Euro

Europe Economics March 2003
Global
Economic Euro Area Data Decoder
& Strategy
Research
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A guide to the euro area macroeconomic

data and policy framework
European Economic
Research
+44-20-7568 4218
edward.stansfield@ubsw.com
Euro Area Data Decoder March 2003
Contents page
Foreword ..................................................................................................... 4
Editor and lead
contributor: Section 1: The euro area policy framework..................................................... 7
Edward Stansfield Chapter 1: Monetary Policy ........................................................................... 8
+44 20 7568 4218
edward.stansfield@ubsw.com
Decision-making bodies....................................................................... 8
ECB personnel.................................................................................... 9
Contributions from:
Policy goals and independence.......................................................... 11
Kevin Gaynor
+44 20 7568 1915 The ECBs policy strategy.................................................................. 12
kevin.gaynor@ubsw.com
Policy instruments: the operational framework .................................... 15
Holger Fahrinkrug Transparency and communication...................................................... 18
+49 69 1369 8280
holger.fahrinkrug@ubsw.com Evaluation: is the ECB behind the curve? ........................................... 19
Stephane Deo The unresolved issue: one size does not fit all..................................... 21
+33 1 48 88 3036
stephane.doe@ubsw.com
Chapter 2: Fiscal Policy............................................................................... 22
The Stability and Growth Pact............................................................ 22
Edward Teather
+44 20+7568 0487 The SGP: Learning by doing .............................................................. 24
edward.teather@ubsw.com
Fiscal sustainability the evidence..................................................... 30
Why privatisation proceeds dont affect the budget deficit .................... 32
Section 2: The data..................................................................................... 33
Chapter 3: Prices........................................................................................ 34
Harmonised Index of Consumer Prices (HICP).................................... 37
National Consumer Price Indices (CPIs) ............................................. 41
HICP Flash Estimate ......................................................................... 43
Producer Price Indices (PPI) .............................................................. 44
Price Surveys.................................................................................... 46
GDP deflators................................................................................... 49
M3 Money Supply ............................................................................. 50
Chapter 4: Whole Economy Data................................................................. 53
Gross Domestic Product .................................................................... 54
PMI Composite Indicator ................................................................... 59
Indicator-based forecasts of euro area GDP ....................................... 60
UBS Warburg Monthly Euro GDP Model............................................. 61
Electronic Research
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2 UBS Warburg
Chapter 5: Industrial Production................................................................... 63

Industrial production.......................................................................... 65
Industrial confidence.......................................................................... 66
Business climate indicator ................................................................. 68
Purchasing Managers Index Manufacturing...................................... 70
Ifo Business Climate Index................................................................. 71
Chapter 6: Services .................................................................................... 74
Reuters Services Index...................................................................... 75
EC Service Sector Survey.................................................................. 76
Chapter 7: Investment................................................................................. 77
Capital goods output ......................................................................... 80
Construction output ........................................................................... 80
Construction confidence survey.......................................................... 81
Chapter 8: Consumer Spending................................................................... 82
EU12 Consumer confidence .............................................................. 85
National consumer confidence measures............................................ 87
Retail sales....................................................................................... 88
New Car Registrations....................................................................... 89
Retail confidence survey.................................................................... 90
Chapter 9: Labour Market ........................................................................... 92
Euro area unemployment data ........................................................... 96
Other labour market data................................................................... 97
Hours worked ................................................................................... 97
Employment...................................................................................... 98
Unit labour costs ............................................................................... 99
Euro area wage bargaining an overview ........................................ 100
Chapter 10: External Trade ....................................................................... 102
Visible trade balance ....................................................................... 105
Balance of Payments....................................................................... 106
Chapter 11: Leading Indicators .................................................................. 108
OECD Composite Leading Indicator ................................................. 112
UBSW Turning Point Indicator.......................................................... 113
UBSW Risk of Recession Indicator................................................... 114
Section 3: Appendices .............................................................................. 115
Appendix 1: A Selective Guide to Euro Area Policy Makers ......................... 116
Appendix 2: A Chronology of EMU............................................................. 117
Appendix 3: Useful Websites..................................................................... 122
Global Economic Analysts......................................................................... 123
3 UBS Warburg
Euro Area Data Decoder March 2003 FOREWORD
Foreword
Following the success of the UBS Warburg Data Decoder An Investors Guide
to the US Economy published in April 2002, we have been asked to deliver a
companion piece for the euro area economy. This publication, we are pleased to
announce, is our response.
The focus of the document is the EU12 aggregate, since that at least in theory is
the data set that the ECB examines in coming to its monthly monetary policy
decisions. While that may be reason enough to focus on the aggregate data, we feel
that the genuine euro area figures are often overlooked since they are less familiar
(and in many cases less timely) than the national alternatives. From a more
pragmatic perspective, incorporating the data from even the three largest euro area
economies would easily have increased the length of the document by another two
to three hundred pages! However, in a few cases, where we feel that the genuine
EU12 data are inadequate either in terms of coverage or in timing, we have included
a discussion of the relevant national series. Despite being a Germany-only series,
we could not bring ourselves to publish this data guide without a discussion of the
single most well-known and widely quoted business survey in Europe the ifo.
As with the US Decoder, we would note that our objective in compiling this
document has not been to produce a prescriptive How to do it guide to
interpreting, let alone forecasting, the euro area economy. Instead, the objective is
more modest namely to assist our readers with a casual (or less than full time)
interest in the economy, to make sense of the daily economic news flow that flashes
across the wires every day of the working week. In other words, its a reference
work that aims to help investors understand and interpret the data flow for
themselves. And as a reference document we make no claims for the light
entertainment value of the pages that follow. (We certainly would not recommend a
cover-to-cover reading in one, two or even three sittings)
But while not designed as a page-turner, a flick though the remaining pages of this
document ought to throw up some points of casual interest. For example, did you
know that the European Commissions retail confidence survey rarely reported by
the news wires has a higher correlation with consumer spending than the
consumer confidence series? And with so many surveys both in Europe and the rest
of the world available, how should we interpret the month-on-month moves in the
data? For example, how significant would a two point fall in the European
Commissions business confidence survey be? Our analysis puts the month-by-
month moves in the data into context. In the above example, our analysis shows that
the average move in business confidence is 1.2 percentage points with the largest
ever fall a decline of five percentage points, suggesting that a two percentage point
move in the series is significant but not shocking.
The organisation of the document is as follows. In Section 1 we provide a run

through of the current monetary and fiscal policy arrangements. Although both are
under review at present to some degree, the nature of change in the euro area
suggests reform by a thousand Councils rather than any sweeping re-assessment
of objectives or policy strategies. As such the descriptions offered here are likely to
4 UBS Warburg
Euro Area Data Decoder March 2003 FOREWORD
be reasonably enduring. The detailed data guide is presented in Section 2 and kicks
off with a look at the various measures of inflation and the money supply as these
are the central focus of the ECBs monetary policy framework. In terms of the
activity indicators, we have taken the view that for any given piece of data, the
interest is not so much in that piece of data per se, but in how that data helps us
build up a picture of activity across the economy as a whole. In the main therefore,
we have grouped the high frequency indicators and surveys under the relevant
expenditure (consumption, investment etc.) or output (industrial production and
services) components of GDP. The exceptions are the labour market data and
leading indicators, which have been given chapters of their own, rather than
including them with the consumption and industrial indicators respectively.
Euro area cynics may be surprised to be presented with an EU12 data guide running
to more than 120 pages even after allowance has been made for two substantial
sections on the respective fiscal and monetary policy frameworks in the single
currency zone. But even a casual glance though the content pages will reveal that
the euro area observer faces some pretty large gaps when it comes to the available
data set. The housing market, manufacturing orders, the labour market, inventories,
corporate profits and household incomes are all areas where the data is either non-
existent or of pretty poor quality.
Despite the limitations, the exercise of putting this guide together has illustrated to
us that the depth, breadth and timeliness of the euro area data set is evolving and
evolving more quickly than many people commonly believe. For example, over the
past year, Eurostat has begun to publish an income breakdown of GDP as well as a
sector-by-sector breakdown of investment in the euro area. But the guide also
highlights that we, as euro area economists and observers, still rely heavily on
survey evidence to add colour to the basic data set. Surveys are still the only real
source of high frequency information on inventories, orders and the two-thirds of
the economy that comprises the service sector.
While we have tried to be comprehensive, there are indicators that are not included
within these pages that arguably could have been. However, we feel that the scope
of the document is sufficient to cover pretty much all the commonly
quoted/reported euro area statistics that an investor might come across from official
Eurostat, Commission and ECB sources.
5 UBS Warburg
6 UBS Warburg
Section 1: The euro area policy framework
7 UBS Warburg
Euro Area Data Decoder March 2003 MONETARY POLICY
Chapter 1: Monetary Policy

The ECB took over monetary The European Central Bank (ECB) formally took over the responsibility for setting
policy in January 1999 monetary policy in the euro area at the beginning of Stage Three of European
Monetary Union (EMU) in January 1999.
The legal framework for monetary policy in the euro area is defined by the
Maastricht Treaty, which was agreed by EU governments in December 1991 and
signed in February 1992, and the Statute of the European System of Central Banks
(ESCB). Within the ESCB, the ECBs policy decisions apply to the Eurosystem
that, beside the ECB itself, also comprises the national central banks (NCBs) of the
EMU member states (see Chart 1).
Decision-making bodies
Governing Council and Monetary policy decisions are made by the ECBs Governing Council whose
Executive Board share membership comprises the six members of the Executive Board as well as the 12
responsibilities in the ECB Governors of the National Central Banks (NCBs) - see Appendix 1 for more detail.
In the ECBs own words, the responsibilities of the Governing Council are:
To adopt the guidelines and take the decisions necessary to ensure the
performance of the tasks entrusted to the Eurosystem; and
To formulate the monetary policy of the euro area, which, according to the
ESCB statute, involves the decisions on intermediate monetary objectives, key
interest rates and the supply of reserves.
The Governing Council While the Governing Council decides the ECBs goals, strategy and interest rates, it
determines the ECBs is the Executive Board, which has responsibility for implementing the Governing
strategy...the Executive Councils policy decisions. The Executive Board of the ECB consists of the
Board implements it President, the Vice President and four other members. In addition to implementing
policy decisions, the Executive Board has responsibility for preparing the meetings
of the Governing Council and oversees the day-to-day running of the Bank.
To provide a forum for discussion of monetary policy issues affecting all EU

members, not just those of the euro area, there is also a General Council. This,
besides the members of the Governing Council, comprises non-EMU central bank
governors, currently those of the UK, Denmark and Sweden. The General Council
has no mandate in regard to the common monetary policy in EMU and its quarterly
meetings do not attract much attention.
National central banks have National central banks of the euro area are less important than the above mentioned
lost importance in the euro institutions of the ESCB as their role is restricted to the execution of the ECBs
area decisions on a national level. However, through the membership of each NCB
governor in the ECBs Governing Council, they have retained some influence on
policy decisions.
8 UBS Warburg
Voting in the Governing Council: today and after EMU enlargement

Governing Council decisions Formally, Governing Council decisions are taken by simple majority voting,
are principally taken by whereby every member has one vote. Although the ECB insists that votes on policy
simple majority voting decisions are extremely rare as most are taken unanimously, this is an important
point, especially in light of the pending EU enlargement.
EU enlargement would boost Even the current size of the Council (18 members) is often criticised as being too
the size of the Council large to allow for timely policy decisions. Without reform, current arrangements
would mean that after the next round of EU enlargement, the Governing Council
could eventually have up to 31 members, which would make it look more like a
monetary policy parliament than an efficient decision-making body.
It is an issue that all NCB governors have equal voting rights regardless of their
economys size. Since some of the smaller countries are less mature than, for
instance, the EU5, and might require significantly higher interest rates, this could
ultimately lead to a policy bias.
To avoid disadvantages of To avoid these potential problems, the ECB has proposed that the voting modalities
a growing Council, a vote in the Governing Council be reformed. Its proposal foresees a maximum of 21
rotation system has been voting members the six Executive Board members and 15 NCB governors. Once
proposed the euro area has more than 15 member states, there will be a system of rotating
voting rights (see the Box on the following page for more detail).
ECB personnel
Although nominations for the ECBs Executive Board, and even more so its
Presidency, are highly political affairs, there are limits to the freedom of
governments as the Treaty rules that:
The President, the Vice President and the other members of the Executive
Board shall be appointed from among persons of recognised standing and
professional experience in monetary or banking matters by common accord of
the governments of the Member States (...), on a recommendation from the
Council, after it has consulted the European Parliament and the Governing
Council of the ECB. (Article 112)
ECB nominations are At the end of the day, ECB nominations are a political matter, but not to a degree
political, but do not that would seem to challenge the central banks independence. The regulations of
challenge its independence the Treaty in this respect, coupled with peer pressure in the European Council,
should prevent such influence, or keep it relatively low. Based on the experience of
the ECBs first three years, the members of the Executive Board have not behaved
in a nationalistic or opportunistic fashion. This makes political wrangling about
ECB positions in the European Council appear irrational. It does, however, suggest
that very rules for filling ECB posts have a role to play in a monetary union that is
not accompanied by political union.
9 UBS Warburg
Chart 1: The structure of the European System of Central Banks (ESCB)
European Central Bank (ECB)
European System of Central Banks (ESCB)

Govern ing Co uncil Executive B oard
European System of Central Banks (ESCB)
Nationale Bank van Belgi/

Banca dItalia
Banque Nationale de Belgique
Eurosystem
Eurosystem
Deutsche Bundesbank Banque centrale du Luxembourg
Bank of Greece De Nederlandsche Bank
Banco de Espaa Oesterreichische Nationalbank
Banque de F rance Banco de Portugal
Central Bank of Ireland Suomen Pankki
Danmarks Nationalbank Sveriges Riksbank
Bank of England
Source: ECB
The ECBs proposal for a new voting system within the Governing Council
Background
On 3 February 2003, the Governing Council of the ECB adopted a Recommendation on an adjustement to voting modalities which will become necessary in
an enlarged euro area. The Recommendation has been submitted the European Council for approval. The Council will decide whether or not to approve the
Recommendation after taking into account the opinions of the European Commission and the European Parliament.
The proposal
Under the ECB's Recommendation, the present system, whereby the Central Bank Governor of each member state recieves permanent voting rights in the
ECB Governing Council will continue until the euro area has more than 15 members. Once there are more than 15 euro area members, NCB Governors will
be assigned voting rights on a rotating basis. The frequency with which an NCB Governor votes, will be determined by his/her country's "rank" within the euro
area. Non-voting NCB Governors will continue to attend Governing Council meetings.
The ranking mechanism

A member states' rank will be determined by a composite indicator calculated from its GDP and the total assets of the aggregated balance sheet of the MFI's
within its territory. The composite ranking indicator will give a weight of 5/6 to GDP and 1/6 to MFI assets
Assigning voting rights - the proceedure
When there are more than 15 NCB Governors but less than 22 When the number of NCB Governors exceeds 21
Group 1 Four votes shared between the five NCB Governors from Group 1 Four votes shared between the five NCB Governors from
member states with the highest ranking member states with the highest ranking
Group 2 Eleven votes shared between the remaining NCB Governors Group 2
Eight votes shared between half the remaining NCB Governors
(rounded up if necessary) selected in order of descending rank
Group 3 Three votes shared between the remaining NCB governors
Source: ECB, UBS Warburg
10 UBS Warburg
The length of Executive According to the Treaty, the length of Executive Board members terms is eight
Board members terms is years. They cannot be re-appointed. Some of the first board members were awarded
normally eight years shorter terms to avoid situations in which all members had to be replaced at the
same time. The first term that ended was that of the Vice President: in May 2002,
Greeces Lucas Papademos replaced the Frenchman, Christian Noyer. Sirkka
Hmlinens (the Finnish member of the Executive Board) term ends in May 2003.
Current ECB President Although appointed for eight years, todays ECB President, Wim Duisenberg, has
Wim Duisenberg is set to announced that he will retire in July 2003. This decision is widely believed to be a
be replaced this year reflection of the disorderly way in which he was appointed in 1998. At that time,
the French tried to insist on Banque de France Governor, Jean-Claude Trichet, as
first ECB President in return for accepting Frankfurt as the location of the ECBs
headquarters. Mr Duisenbergs willingness to step down early is usually portrayed
as being part of a gentlemens agreement that made a compromise possible at the
time.
Policy goals and independence

The ECBs primary objective The objectives of the Eurosystem are defined in Article 105 of the Maastricht Treaty:
is price stability...
The primary objective of the ESCB shall be to maintain price stability.
Without prejudice to the objective of price stability, the ESCB shall support the
general economic policies in the Community with a view to contributing to the
achievement of the objectives of the Community as laid down in Article 2.
...Defined as 0-2% inflation The ECB defines price stability as follows:

Price stability shall be defined as a year-on-year increase in the
Harmonised Index of Consumer Prices (HICP) for the euro area of below
2%.
It has been made clear that this is a medium-term objective and that inflation can
exceed 2% at times without a mechanistic reaction from the ECB. Even so, many
have argued that 2% inflation is an over-ambitious target for the euro area, given
the different shape and maturity of the economies that make up the euro area.
The objective, like other Both the ECBs predominant focus on inflation and the definition of price stability
institutional elements, is are an inheritance from the Bundesbank, whose statutes sounded strikingly similar
inherited from the to the ECB in this respect. Politically, it may be seen as a tribute of other member
Bundesbank states to the Germans in return for their readiness to sacrifice the DEM.
Other parts of the Treaty and the ESCB Statute are also reminiscent of the
Bundesbank set-up, not least the parts regulating the ECBs independence and the
ECBs role in general policy discussions in the EU.
The ECBs independence is Article 108 of the Treaty states that:

enshrined in the Maastricht
When exercising the powers and carrying out the tasks and duties
Treaty
conferred upon them by this Treaty and the Statute of the ESCB, neither the
ECB, nor a national central bank, nor any member of their decision-making
bodies shall seek or take instructions from Community institutions or
bodies, from any government of a Member State or from any other body.
11 UBS Warburg
The ECB also plays a role as In addition, the ECB has to be consulted on any proposed Community act in its
advisor to EU institutions fields of competence; and by national authorities regarding any draft legislative
provision in its fields of competence ..., which gives it a more powerful role in
general economic policy than most other central banks.
Finally, the ECBs financial structure, which is kept separate from other EU or
national institutions budgets, is also designed to enhance the ECBs independence.
The ECBs policy strategy

The ECB operates a two- While the ECBs policy objective is clear enough to deliver price stability over
pillar monetary policy the medium term its monetary policy strategy is a little less so. The ECBs
strategy monetary policy strategy is based on a two-pillar approach that involves a close
analysis of monetary developments on the one hand, and a wide range of other
economic and financial indicators on the other.
...which is reflected in the The first pillar reflects the prominent role of money for a central bank. It is as a
setting of a reference value result of fundamental considerations, which suggest that inflation is a monetary
for M3 growth phenomenon. Consequently, monetary variables can be used as leading indicators
for future inflation. This is the reason why the ECB has given it a greater role in its
analysis of risks to price stability than any other single economic variable.
The prominence of money is further illustrated by the fact that the ECB has a
Money has a prominent role
reference value for the broad M3 aggregate, which it sets each year in order to state
in the ECBs strategy,...
the pace of M3 growth that it considers consistent with price stability. (The M3 data
itself is discussed on page 50.)
Chart 2: The ECBs monetary policy strategy
Pr im ary ob je ctiv e of p ric e s ta bility
G ove rn in g Cou ncil

system a tica lly co m bine s a ll
in fo rm a tio n in o rd er to take
m on etar y po licy de cision s
An alysis a cco rd in g
An alysis focusing o n a
a pro m ine nt
cross- wid e ra ng e of othe r
ro le to m o ne y
che ckin g eco no m ic an d fin an cia l
(sig na lle d by the re fer en ce
in dicators
value fo r M 3 g ro wth )
Ec on om ic info rm ation
Source: ECB
12 UBS Warburg
The M3 reference value of the However, the first pillar of the ECBs strategy is not comparable with the
ECB is not to be seen as a Bundesbanks M3 target. The ECB uses monetary variables as an indicator of
money supply target potential future inflation developments by analysing the forces behind deviations in
actual M3 growth from the reference value. But the ECB does not attempt to keep
money supply growth at the reference value at any particular point in time. The
reason lies in the complexity of the relationship between money, prices and
economic activity as well as uncertainty about structural changes in the banking and
financial systems, and potential special factors that may change it.
M3 has not played a Chart 3 illustrates that variations in the pace of M3 growth have had little influence
dominant role for euro area on ECB interest rates in the first three years of monetary union. In fact, in some
interest rates periods, strong M3 growth coincided with low interest rates, and weak M3 growth
with higher interest rates. That M3 has not been the main policy driver was often
underpinned by the ECB itself: it regularly provided excuses why M3 growth
deviated from the reference value without affecting inflation. Despite the ECBs
efforts to explain its monetary analysis, the first pillar of its strategy has often been
criticised for lack of transparency and for conceptual failure.
Besides money, the ECB The second pillar of the ECBs strategy comprises the analysis of a wide range of
analyses a broad range of economic and financial indicators. The ECB reviews developments in output,
other economic indicators demand, and labour market conditions, a range of price and cost indicators, and the
balance of payments. It considers the impact on demand andfluctuations in asset
prices and the exchange rate as well as their information content regarding the
expectations of market participants.
Eurosystem staff prepares Under the second pillar, the research staff of the Eurosystem (the ECB and NCBs)
economic projections twice a prepares economic projections twice a year. These are published in the June and
year as an input to the December Monthly Bulletins. The projections are meant to provide a basis for
Governing Council discussions in the Governing Council and to underpin the forward-looking character
discussions of the monetary policy strategy. They also serve as a means of communication with
the public as they form a reference for the ECBs assessment of economic
developments, changes in which could signal looming changes in interest rates.
However, since the ECB publishes the projections in the form of ranges, their
information content is limited. Finally, the ECB is keen to emphasise that the
projections are not forecasts of the Governing Council, but a scenario independently
produced by Eurosystem staff.
Conflicting signals from the The ECBs monetary policy strategy has often been criticised. Many commentators
two pillars have contributed dislike the prominent role for money, eg, owing to uncertainty about the
to this transmission mechanism in EMU or concerns about stability of money demand.
Even some of those who would accept this role, suggest that the monetary analysis
should be integrated into the general economic analysis under the second pillar,
which would, de facto, be a demotion of the importance of the monetary analysis,
putting it at the same level as other parts of the assessment of economic conditions.
The two-pillar strategy is But the most valid criticism is probably that the two-pillar strategy is hard to
hard to communicate communicate. For example, conflicting signals from both strategy pillars, eg, a
situation in which M3 growth exceeds the reference value while activity indicators
point to diminishing inflation pressure, are hard for financial markets to digest, even
if the ECB repeats its assessment in regular intervals.
13 UBS Warburg
How much money? Deriving the M3 reference value

The ECB derives the M3 reference value using an economic identity labelled the
quantity equation, which states that the change in the money stock (M) in an
economy equals the change in nominal transactions approximated by real GDP
growth (Yr) and inflation (P), minus the change in velocity (V). Put simply, the
latter describes the speed with which money changes hands in an economy.
Quantity equation: M = Yr + P V
To derive the M3 reference value, ie, the pace of monetary expansion consistent
with price stability in the euro area, the ECB applies its quantified inflation
objective (max. 2%) for P, a medium-term assumption regarding potential output
growth or trend growth (2.0-2.5%) and results of its money demand analysis that
suggest that money velocity is declining by between 0.5% and 1.0% per year.
When applied to the quantity equation above, these values put the reference value
in a range of 4.5% to 5.5%. Since the start of EMU, the ECB has kept the reference
value constant at 4.5%, but has rarely seen actual M3 growth close to this level.
The M3 reference value has been (and still is) the subject of wide-ranging criticism.
At the peak of the New Economy boom in 2000, many commentators argued that
the reference value was too rigid as trend growth in the euro area was assumed to be
higher than the range applied by the ECB. Considering the slowdown in investment,
among others, this criticism does not seem to be valid any more. But at least the
components make it clear that the concept of the quantity equation would leave
significant scope for variations in the reference value depending on the underlying
assumptions and parameters. Uncertainty over potential growth and money
demand/money velocity calls for a relatively flexible handling of deviations from
the reference value, which the ECB has indeed applied so far.
Chart 3: M3 growth and the ECBs refi rate

9.0
Percent
8.0
Euro area M3
growth, yoy
7.0
6.0
5.0
4.0
3.0 Fixed/minimum
refi rate
2.0
1.0
0.0
Jan 99 Jul 99 Jan 00 Jul 00 Jan 01 Jul 01 Jan 02 Jul 02 Jan 03
Source: ECB, Datastream, UBS Warburg
14 UBS Warburg
The ECB is set to review In light of this criticism, the ECB has announced that it will undertake an in-depth
its strategy this year review of its policy strategy in the first half of 2003. The outcome of this review is
open, but the current strategy has strong defenders on the Executive Board, such as
its creator, Chief Economist, Otmar Issing. But some changes to the strategy
discussed above could be announced in due course. Even if some aspects of the
strategy are reformed, the overriding policy objective of price stability will remain
in place, and hence, the ECBs policy will not change significantly.
Policy instruments: the operational framework

In its own words, the ECB steers the level of short-term interest rates in order to
achieve its main policy objective, price stability, assuming that variations in short-
term interest rates influence the economy and the price level via the monetary
transmission mechanism. The policy strategy described above is designed to
determine the appropriate level of short-term interest rates at any point in time. The
operational framework determines how this interest rate level can be achieved.
The ECB has several The ECB has several instruments to steer interest rates. It can do so by signalling its
instruments to steer policy stance, eg, by setting conditions for transactions with counter-parties, and
interest rates influencing liquidity in the money market as the monopoly supplier of the
monetary base, as the ECB puts it. The monetary base in the euro area comprises
currency in circulation, deposits held by counter-parties with the Eurosystem and
recourse to the Eurosystems deposit facility (see below). Table 1 summarises the
main instruments of the ECBs policy operations, which can be divided into open
market operations and standing facilities.
Table 1: Eurosystem open market operations and standing facilities
Monetary policy Types of transactions Maturity Frequency Procedure

operations Liquidity providing Liquidity absorbing
Open market operations
Main refinancing Reverse transactions Two weeks Weekly Standard tenders
operations
Longer-term Reverse transactions Three months Monthly Standard tenders
refinancing operations
Fine-tuning Reverse transactions Foreign exchange Non-standardised Non-regular Quick tenders

operations swaps
Foreign exchange Collection of fixed-term Bilateral procedures
swaps deposits
Reverse transactions
Outright purchases Outright sales - Non-regular Bilateral procedures
Structural operations Reverse transactions Issuance of debt Standardised/ Regular and Standard tenders
certificates non-standardised non-regular
Outright purchases Outright sales Non-regular Bilateral procedures
Standing facilities
Marginal lending Reverse transactions Overnight Access at the discretion of counter-parties
Deposit facility Deposits Overnight Access at the discretion of counter-parties
Source: ECB
15 UBS Warburg
In practice, the rate on the deposit facility, which is the one that banks receive when
Deposit and marginal lending
they make (overnight) deposits at the Eurosystem, sets a floor under money market
rates set a corridor for money
rates. The rate on the marginal lending facility, at which banks can borrow from the
market rates
central bank overnight, usually represents a ceiling for money market rates as it is
so high that banks only use this facility as a last resort.
The refi rate is the most In principle, overnight money market rates can fluctuate within the corridor set by
powerful and most closely the standing facilities outlined above. In practice, they usually stay close to the rate
watched ECB tool that the ECB applies to its main refinancing operations. These operations are the
most important monetary policy instrument in the euro area, both because of their
importance for the level of money market interest rates and because they are the
main source of liquidity in the banking system. Hence, the refi rate is the most
powerful and most closely watched tool that the ECB has at its disposal.
In the weekly refi operations, which normally have a maturity of two weeks, the
ECB grants loans to its counter-parties against assets as collateral. It does so in the
form of standardised tenders, either at a fixed or variable rate. In fixed rate refis, the
ECB pre-announces the interest rate at which banks can borrow and counter-parties
bid for the amount they wish to transact at this rate. In variable rate refis, counter-
parties specify both the amount of money and the interest rate at which they want to
enter the transaction. The Governing Council may set a minimum bid rate for
variable rate refis as it currently does in order to give banks an orientation.
Chart 4: ECB and overnight money market rates

6.0
Percent
5.5
5.0
4.5
Marginal lending rate
Marginal refi rate

4.0
3.5
EONIA overnight rate
Fixed/minimum
3.0
refi rate
2.5
Deposit rate
2.0
1.5
1.0
Jan 99 Jul 99 Jan 00 Jul 00 Jan 01 Jul 01 Jan 02 Jul 02 Jan 03
Source: Datastream, UBS Warburg
In 2000, the ECB switched Prior to June 2000, all refi operations were conducted at a fixed rate. Since then, the
from fixed to variable refis ECB has used variable rate operations with a minimum bid rate and a multiple rate
procedure. The latter describes a system by which each bidder has to pay the
interest rate attached to his (accepted) bid (by contrast, in a single rate procedure,
the marginal rate would be applied to all bids).
16 UBS Warburg
The ECB decides about In both fixed and variable rate refis, the ECB decides the amount of liquidity that it
the amount of liquidity that wishes to allocate. In the former case, it will usually provide liquidity by applying
it wishes to allocate the ratio between the total amount to be allocated and the amount of all bids to each
counter-partys bid. In variable refis, the bids with the highest rate attached are
satisfied first, followed by bids at successively lower rates until the total amount of
liquidity to be allocated is exhausted. At the lowest accepted rate, the marginal rate
of allotment, bids are satisfied pro rata to reach the desired total liquidity provision.
In addition to the main weekly refinancing operations, the ECB also offers longer-
term refis with a three-month maturity. In these operations, however, the ECB does
not set the interest rate, but acts as a rate taker in order not to interfere with market
interest rates at more than one point of the maturity spectrum.
Beyond the refi, the ECB has Beyond the refi, the ECB has several ad hoc fine-tuning instruments at its disposal,
several fine-tuning both liquidity providing and liquidity absorbing, as summarised in Table 1. These
instruments at its disposal instruments are designed to smooth temporary spikes in liquidity needs and interest
rates, as can be seen in Chart 4. These spikes may occur, eg, towards the end of a
reserve period when banks struggle to fulfil their minimum reserve requirements.
They may also occur in the event of expected interest changes when banks bid too
much (eg, as they expect a rate hike) or too little (eg, as they expect a rate cut
during the current refi period) in the weekly refi operations. Such fine-tuning
operations have been rare events so far and are mostly carried out in the form of so-
called quick tenders, which allow the ECB to announce a liquidity allocation
within an hour of the announcement of the operation.
Table 2: ECB rate changes in the first three years of EMU
With effect Deposit Main refinancing operations Marginally

facility Fixed rate Variable rate lending
Min. bid rate facility
1999 1 January 2.00 3.00 4.50
4 January 2.75 3.00 3.25
22 January 2.00 3.00 4.50
9 April 1.50 2.50 3.50
5 November 2.00 3.00 4.00
2000 4 February 2.25 3.25 4.25
17 March 2.50 3.50 4.50
28 April 2.75 3.75 4.75
9 June 3.25 4.25 5.25
28 June 3.25 4.25 5.25
1 September 3.50 4.50 5.50
6 October 3.75 4.75 5.75
2001 11 May 3.50 4.50 5.50
31 August 3.25 4.25 5.25
18 September 2.75 3.75 4.75
9 November 2.25 3.25 4.25
2002 6 December 1.75 2.75 3.75
2003 7 March 1.50 - 2.50 3.50
Source: ECB
17 UBS Warburg
Transparency and communication

The ECB has several The ECB uses several channels to communicate its views to the public. Apart from
channels to communicate, press notices that it issues on various aspects of public interest, it holds a press
via press conferences,... conference chaired by the President or Vice President in order to brief the media
after the first meeting of the Governing Council each month. [Although the
Governing Council meets twice a month only the first of these meetings (typically
on the first Thursday of the month) will, as a rule, consider monetary policy.]
...the Monthly Bulletin, and In addition, the ECB publishes a Monthly Bulletin whose Editorial, similar to the
www.ecb.int monthly press conferences, provides an update regarding the analysis under the two
pillars of its monetary strategy and other important issues. The Monthly Bulletin
also contains regular research articles on issues considered to be of relevance for
monetary policy. Finally, it provides a raft of euro area statistics, including the
ECBs data on monetary developments. Further information, eg, on speeches of
Executive Board members, monetary policy operations, legal and banking issues
etc. can be found on the ECBs website.
Speeches and interviews also Speeches and interviews of ECB Council members are closely monitored by
play a role in the information financial market players. Since the ECB is well aware of the attention paid to its
strategy speakers, at least certain speakers, it uses this channel of communication to provide
views to the public whenever it wishes to have greater attention than the regular
publications attract. On some occasions, financial markets have been prepared for
looming rate changes, not officially, but apparently deliberately, by interviews of
influential members of the ECBs Executive Board.
This has occasionally led to In the early days of the ECBs operations, there used to be complaints about the
confusion in the past, but has uncoordinated way in which members of the Governing Council appeared in the
improved more recently public, sometimes seemingly contradicting each other regarding the assessment of
inflation risks or other economic matters. This has changed recently, as the ECB
itself is exerting more discipline today in the distribution of public statements, and
because its watchers have become used to the encryption of messages. It has
become clear that the ECB President, Mr Duisenberg, the Chief Economist, Mr
Issing, and a few other members of the Executive Board almost exclusively provide
important new information. In terms of public representation, the weight of the
NCB governors, who mainly cover their home markets in terms of information
provision, has diminished.
(Lack of) ECB transparency All in all, (lack of) transparency, not least due to reluctance to publish minutes of its
and problems with its Council meetings, and problems with the communication consistency have been
communication have been among the issues most frequently criticised regarding the ECBs performance. But
criticised the situation has improved. To some, the frequency at which Council members
address the public may appear to be too high, but this is a consequence of the large
number of countries participating in EMU and will be hard to change. Still, the
communication pattern of the ECB may undergo further change in the future. It is,
however, unlikely to become as clear as that of national central banks, owing to the
size and heterogeneity of the euro area for which it sets monetary policy.
18 UBS Warburg
Evaluation: is the ECB behind the curve?

Interest rates have been set As we have shown above (see Chart 3, p14), the pace of money supply growth does
in a rather pragmatic way not seem to have been a great influence on ECB policy rates. Our perception is that
interest rates have been set in a pragmatic way, despite the existence of the ECBs
complex and well-argued strategy. This pragmatic approach, alongside problematic
communication, has made the ECB vulnerable to criticism.
The ECB has been criticised During its first three years in operation, the ECB has been criticised from all sides.
from all sides... Some argued that policy rates were too high most of the time, be it because of a
perceived inflation obsession of the Governing Council, overly optimistic growth
projections, or because decisions to lower interest rates were taken too late.
...but mainly for being behind Others argued that the ECB did not take the first pillar of its strategy seriously
the curve in an economic enough, that the recent M3 overshoot could cause inflation and should therefore be
downturn countered by higher interest rates. The most common criticism, especially at times
when the economy has been struggling, and especially from countries with central
banks that have different objectives from the ECBs, is that the ECB is strangling
the economy by running an overly restrictive policy.
The policy stance can be One way of assessing this issue is to compare ECB policy rates with the level
assessed using the Taylor suggested by a monetary policy rule. The most prominent rule was originally
rate presented by John Taylor to assess the monetary policy stance of the Federal
Reserve in the United States. It states that policy rates should be set according to a
long-term equilibrium level of short-term rates, adjusted for the difference between
current inflation and the (central-bank-determined) desired level of inflation, and
the amount of spare capacity in the economy, which can be approximated by the
output gap.
Chart 5: ECB policy rates and the Taylor rule
6.00
%
Traditional Taylor rate
5.00
4.00
3.00
Taylor rate based on
core inflation Refi rate
2.00
1.00
1999 2000 2001 2002 2003
Source: ECB, UBS Warburg;

Model assumptions: OECD output gap estimates, 2.5% equilibrium real interest rate, 2.0% inflation objective
19 UBS Warburg
In Chart 5, we have calculated the Taylor Rule in two ways using both the
headline and core measures of the HICP for the term describing the deviation of
current inflation from the target. Although fundamentally questionable in this
context, we find this distinction interesting because there have been calls on the
ECB to use core rather than headline inflation as a policy objective as it is
supposedly a better reflection of underlying trends in the price level.
This approach does not Chart 5 shows that since the start of EMU, the refi rate has been between the two
support the notion that the measures of the Taylor Rule most of the time, but closer to the level of the
ECB is behind the curve traditional rule that uses headline inflation. Since the second half of 2001, however,
policy rates have been lower than would have been suggested by either version of
the Taylor rule. Consequently, this approach would not support the argument that
ECB policy has been excessively tight.
Another tool to analyse the monetary policy stance is to consider a Monetary

Conditions Index (MCI) or a Financial Conditions Index (FCI). Both are designed
to provide a gauge of the interest rate equivalent of changes in overall monetary
conditions as reflected in domestic interest rates and changes in the real effective
exchange rate. The FCI also comprises bond yields.
Chart 6: Overall monetary conditions not to be held responsible for the growth slowdown
5.0 -4.0
% yoy Financial conditions index
(two quarter lead, rhs)
-3.5
4.0
-3.0
3.0 -2.5
-2.0
2.0
-1.5
1.0
Euro area GDP -1.0
growth (lhs)
0.0 -0.5
0.0
-1.0
Interest rate 0.5
equiv., % (rev.)
-2.0 1.0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Neither would overall Chart 6 uses the broader FCI and shows that overall financial conditions in the euro
financial conditions argue area have eased significantly since the start of EMU. This reflects two things: first,
that ECB policy was too tight interest rates and bond yields converged at the low end of the range set by the levels
in the individual countries participating in EMU, and; second, the euro has
depreciated significantly since its launch in 1999. Hence, overall financial
conditions would not indicate an overly tight monetary policy of the ECB and
cannot be held responsible for the slowdown in euro area GDP growth since 2000.
20 UBS Warburg
The unresolved issue: one size does not fit all

Perceptions of ECB policy We believe that one of the reasons why many still consider ECB interest rates to be
could be flawed by excessive too high is that market participants and analysts focus too much on Germany when
focus on German data assessing economic conditions in the whole of the euro area. In the financial
markets, economic data releases from Germany still attract more attention than data
from any other country, or aggregate euro area data.
Germany requires lower Since Germany is the slowest-growing economy of the euro area with inflation well
interest rates than others in below average, it requires significantly lower interest rates than any other individual
the euro area country or the average. This is illustrated by Chart 7, which shows Taylor rate
estimates for all member states and for the euro area as a whole.
According to our calculations, the Taylor rate for the euro area as a whole would be
about 2.6% in 2003 close to the current level of the ECBs refi rate of 2.50%. For
11 countries, this is too low and might thus cause an inflation problem. This level is
too high, and according to our calculations, substantially too high for only one
country, ie, Germany. Consequently, approximating economic conditions in the
euro area using German data will give rise to the conclusion that ECB policy is too
tight.
Chart 7: The ECB cannot set an appropriate policy for each member state
Germany
Euro area
Netherlands
Italy
Belgium
Portugal
Austria
Finland
France
Ireland
Spain
Greece
0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00
2003 Taylor rate, %
Source: UBS Warburg

Model assumptions: OECD output gap estimates, 2.5% common equilibrium real interest rate, 2.0% inflation objective,
UBS Warburg growth and inflation forecasts
ECB policy has been about We would argue that, broadly speaking, ECB policy has been fair for the euro area
fair for the euro area, but the as a whole in the first three years of EMU. At the very least, we cannot see major
one size fits all problem will policy errors. Going forward, the problems of a common monetary policy for a
persist large number of heterogeneous economies could become even more pronounced.
Given that Germany faces both excessively tight monetary and fiscal policy, the gap
between the level of interest rates appropriate for the euro areas largest economy
and that desired by faster-growing countries might even widen. The possible EMU
entry of EU accession countries later this decade might even widen the range of
required interest rates.
21 UBS Warburg
Euro Area Data Decoder March 2003 FISCAL POLICY
Chapter 2: Fiscal Policy

Unlike monetary policy, where responsibility has been delegated to a single pan-
Fiscal policy operates on two
euro area body, which sets policy to achieve a pan-euro area target on pan-euro area
levels in the euro area
data, fiscal policy is controlled at two levels in the euro area. Control over taxes and
public expenditure remains with national governments. But, in an effort to ensure
that divergent fiscal policies do not create problems for the implementation of
monetary policy, and to ensure that national public finances remain on a sustainable
footing, member states have agreed to some overarching fiscal rules, contained in
the Stability and Growth Pact (SGP).
This dual aspect to fiscal policy means that the European budgetary season has, in
National policy is, in
effect, been elongated into an almost continuous cycle. The process begins each
principle, constrained by the
year with the French Lettres de Cadrage in late April/early March, when the Prime
SGP
Minister sets out expenditure objectives for each of his Ministers. And it continues
through Budget statements in the autumn, the submission of Stability Programme
updates in the final weeks of the year, and concludes with the Councils
examination of these programmes in the spring of the following year.
The Stability and Growth Pact itself has come under mounting criticism in the past
year or so particularly for being too rigid in what has proved to be difficult
economic conditions. The European Commission have put forward proposals to
change the way the Pact is administered and to introduce greater flexibility into its
interpretation and implementation while maintaining, and arguably strengthening,
its underlying values namely fiscal sustainability. In the following pages, we set
out the key features of the SGP and the European Commissions latest proposals.
However, at present the Commissions proposals are just that, proposals.
The Stability and Growth Pact

The SGP aims to ensure euro The Stability and Growth Pact (SGP) is the mechanism used to provide some
area public finances remain measure of co-ordination of member states fiscal policies at the euro area level.
sustainable... While recognising the fact that ultimate responsibility for tax, spending and the
overall stance of fiscal policy rests with Member State Governments, the SGP
provides some overarching rules and guidelines designed to enshrine budgetary
discipline as a core feature of fiscal policy within the euro area. The SGP is
designed to deter national budgetary action that could have adverse consequences
for the euro area as a whole, while allowing sufficient leeway for national fiscal
policies to play a stabilisation role.
At the time of writing, the SGP is the subject of much criticism, as it appears to be
forcing several economies into an unwelcome pro-cyclical tightening of fiscal
policy. Public statements from the European Commission, the ECB and many
national Finance Ministers suggest that wholesale changes to the Pact are unlikely
at least in the near term. But we would be surprised if the next few months did not
deliver some compromises on a more flexible interpretation of the way the Pact is
applied in practice. Agreement on a wider set of factors to be taken into
consideration when deciding whether or not a deficit was excessive or not cannot be
ruled out. Nevertheless, for the time being we are limited to describing the Pact as it
currently stands.
22 UBS Warburg
Agreed in 1997, and in force since 1999, the SGP evolved from the Maastrict
Treaty rules (Article 104), which laid out the route to fiscal convergence required in
order for a state to qualify for membership of the single currency. The main
difference is that the SGP strengthened the role of ongoing budgetary surveillance
by the Commission and by ECOFIN. The SGP also clarified both the rules and the
timetable by which warnings and sanctions are issued and imposed.
...by tasking member states There are three aspects to the SGP. The first aspect is the political commitment to
to keep budget deficits sub- sustainable national fiscal strategies and an undertaking to keep government deficits
3% of GDP at all times within the 3% of GDP reference level. This is set out in the Amsterdam European
Council resolution of 17 June 1997. The second aspect is one of preventative
ongoing multilateral surveillance of budgetary positions to try and prevent national
deficits exceeding 3% of GDP. To this end, Council Regulation 1466/97 requires
member states to submit annual stability programmes to the European Commission.
The third aspect is one of dissuasion. Council Regulation 1467/97 sets out the
enforcement action (both the scope and the timing) that the Council can take against
any member state under the excessive deficit procedure (EDP).
and to keep budgets close The primary requirement of the SGP, is that member states pursue a balanced fiscal
to balance, or in surplus, as a policy. In the words of the Amsterdam European Council Resolution on the SGP:
rule ....adherence to the objective of sound budgetary positions close to balance or in
surplus will allow all Member States to deal with normal cyclical fluctuations while
keeping the government deficit within the reference value of 3% of GDP.
However, the Pact does allow governments to run deficits in excess of 3% of GDP
if the deficit is deemed to be exceptional and temporary. A deficit in excess of 3%
of GDP can be considered exceptional and temporary if:
It results from an unusual event outside the control of the Member State
concerned and has a major impact on the financial position of the general
government; or
Some deviation from these There is a decline in real GDP of at least 2% on an annual basis. If the decline in
rules is allowed in real GDP has been greater than % of GDP but less than 2%, the member state
exceptional circumstances concerned may argue that the downturn is nevertheless exceptional. In such a
case, the Council has room for discretion in deciding whether or not a deficit
that exceeds 3% of GDP is excessive.
Member States must also The second requirement of the SGP is that between mid-October and 1 December,
submit annual Stability member states submit annual Stability Plans to ECOFIN and to the European
Plans Commission. The purpose of the stability programmes is to demonstrate that fiscal
policy remains consistent with the medium-term objective of budgetary balance.
(The surveillance process is summarised in Chart 8 below.) The stability
programmes are based on common macro-economic assumptions issued by the
Commission. At a minimum, the programmes must include four-year projections,
an assessment of the underlying cyclically adjusted budget position, a set of
standardised tables to aid cross country comparability and information on the
quality and sustainability of public finances, including long-term projections of the
budgetary implications of an ageing population.
23 UBS Warburg
The annual stability programme updates are then examined by the European
Commission, the Economic and Financial Council and on the basis of reports from
these groups, ECOFIN issues an opinion on the Stability programme updates by the
end of February. In the event that significant actual or expected slippage from
previously agreed budget targets is identified, the Council can issue an early
warning to the member state concerned. The early warning carries no formal
penalties or sanctions but is a signal that extra vigilance is required.
.. and regular statistical In addition to the stability programmes, member states submit reports on recent and
updates to the European prospective financial developments to the Commission twice a year. In the event
Commission that a Member State records a deficit in excess of 3% of GDP, the European
Commission will initiate the excessive deficit procedure issuing an opinion and a
recommendation to ECOFIN. If the Council agrees with the Commissions
assessment a recommendation is issued, specifying that the member state must
correct the deficit within one year and giving a deadline of four months for effective
action to be taken. The EDP process is summarised in Chart 9 below.
Failure to comply with the If the Council decides that no effective action has been taken within four months, it
SGP can, in theory, result in may make public its recommendation to the Member State concerned. Within two
fines on the errant Member months of this decision, the Council may impose sanctions on the non-compliant
State. Member State. In the first year, the member state must pay a non-interest bearing
deposit equal to 0.2% of GDP and a variable component equal to 0.1% of the
difference between the deficit and the 3% of GDP ceiling up to a maximum of 0.5%
of GDP. In each subsequent year until the excessive deficit is eliminated, the
sanctions can be intensified by re-applying the variable component of the above
formula. If after two years, the Council judges that the excessive deficit has not
been eliminated, the deposit is converted into a fine and is distributed among
member states without an excessive deficit, according to their share of euro area
GDP.
The SGP: Learning by doing
Following the surprising disappointments in the Portuguese, Greek and German

budgets for 2001 and (in the case of Germany) 2002, the shortcomings in the
European Unions Growth and Stability Pact have become increasingly apparent.
Revision of Stability and Those shortcomings have become more meaningful with excessive deficit
Growth Pact proposed by procedures for Portugal and Germany that could theoretically result in a significant
European Commission fine. With the first of these procedures already underway when the President of the
European Commission called the rigidities in the Stability and Growth Pact
stupid, it was clear that the mechanism had lost credibility and that change was in
the pipeline. Proposals by the Commission (unveiled on 27 Nov 2002), if endorsed
by Ministers, would remove some of the rigidities but may not be sufficient to
change euro area governments fiscal policy behaviour.
24 UBS Warburg
25 UBS Warburg

Chart 8: Stability and Convergence Chart 9: Excessive Deficit Procedure
Blank space here Blank space here

Blank space here
Time Member States Commission EFC Council
Commission
Provides assumptions on Biannual reporting
main extra-EU variables 1 Mar (Reg. 3605/93
& 1 Sept and 4751/00)
Report 104(3)
2 weeks Opinion
104(4)
EFC
Discusses main assumptions (June/July) Opinion 104(5)
3m Recommendation to MS: Recommendation 104(6)
- Effective action within 4 Decision on existence of
months at most excessive deficit 104(6)
Member States - correct excessive deficit Recommendation 104(7)
Submission of programmes 4m within t+1 (Reg. 1467/97)
- New programmes
- Annual updates (mid October to 1 Dec)
Other information
7m
Yes No Publication of 104(7)
Examination of Programmes Monitoring of implementation Effective action
Recommendation recommendation 104(8)
Commission Commission 1m
Individual assessment Assessment
- All programmes - programme updates, aggregate view (winter)
Recommendation for Council Opinion - Budget execution t, plans t+1 Yes No Notice to take measures
- New programmes Recommendation for Council recommendation 8m Effective action Recommendation
- In case of significant divergence of budget 104(9)
- Annual updates examined by council from target
2m
10m Yes Compliance No Decision on sanctions

EFC EFC Recommendation
with notice? 104(11)
Assessment: Examination:
- New programmes - Annual updates not Assessment
- Annl updates examined examined by the council
by the council
Consultation on
Council opinion Yes No Annual assessment:
- All programmes Effective action
examined by the Council Recommendation intensification of sanctions
Council Council Progress in correcting Abrogation of sanctions

Recommendation
excessive deficit 104(12)
Examination Opinion Monitoring Recommendation
(before the end of February) (Early warning)
Abrogation of decision on
Correction of
Recommendation excessive deficit and of all
excessive deficit
sanctions 104(12)
Blank space here Blank space here

Source: European Commission Source: European Commission
The European Commissions proposals

Focus of SGP shifted to The Commission has presented five proposals designed to shift the focus of the
cyclically adjusted budget Stability and Growth Pact (SGP) away from fixed budgetary targets towards an
balance process of underlying adjustment. The proposals are as follows.
1) Establish budgetary objectives that take account of the economic cycle. This
implies that the close to balance or in surplus requirement of the SGP should
apply to cyclically adjusted budget deficits rather than nominal budget deficits as
presently are the case. However, the 3% deficit criterion remains a nominal concept.
2) Establish transitional arrangements for countries with underlying deficits

exceeding the close to balance or in surplus requirement of the SGP. This
proposal is defined in such a way that countries with cyclically adjusted budgets not
yet in, or close to, balance should tighten the underlying (cyclically adjusted)
budgetary position by at least 0.5% each year until a close to balance or surplus
position has been reached. The commission also proposes that this adjustment
process should be more aggressive for countries with higher deficits and debt.
3) Avoid pro-cyclical budget policies in good times. This proposal suggests that
countries do not adopt pro-cyclical policies during periods of favourable growth.
4) Ensure public finances contribute to growth and employment. Member states

may, if they have made substantial progress towards a balanced budget and have a
debt level below 60%, run a budget deficit in order to finance economic reform. In
such a case the expansion in the deficit should not risk breaching the 3% of GDP
deficit reference value.
5. Make the sustainability of public finances a core policy objective. This

proposal aims to bring the level of debt explicitly into the regular assessment
process of Member States fiscal policies within the SGP framework.
The Commission has also proposed measures to improve the implementation of the
SGP. These measures include the reaffirmation of political commitment to the SGP
especially to reduce the cyclically adjusted deficit by at least 0.5% of GDP a year
until close to balance and adopt a satisfactory rate (which has yet to be defined) of
debt reduction for countries with high debt levels. The measures also include
proposals to step up the quality and communication of analysis of deficits during
the year and, most significantly, adopt a more activist position on enforcement
procedures. The more activist stance taken by the European Commission would be
based on three proposed factors, which would be taken into account before the
issuance of an official early warning on the deficit. These would be the size of
budgetary slippage relative to the planned budget, whether cyclical or discretionary
factors were to blame, and the potential for the deficit to breach 3% of GDP.
Importantly, none of these proposals require a change in existing legislation. The

Commission envisages that Member States would commit to these proposals at the
2003 Spring European Council.
26 UBS Warburg
What do these proposals mean?

3% of GDP reference value The 3% of GDP budget deficit reference value has not changed and will continue to
remains key be used to determine whether an excessive deficit exists. This reference value will
continue to be applied to the nominal (non-cyclically adjusted) deficit. However,
these proposals do suggest that the commission will be able to bring pressure to
bear on member states that do not deliver or do not promise progress on deficit
reduction when nominal deficits are some way from 3%.
Flexibility has been That said, flexibility has also been introduced. Any mention of a specific time frame
introduced... for all member states to reach a close to balance or surplus (previously 2004 and
then implicitly 2006) has been removed. The focus is now in a transition towards
the close to balance or surplus position on a cyclically adjusted budget balance
measure, largely irrespective of the starting point in any given year.
... but only for countries with Member States will be able to run small budget deficits either in the short or
low debt to GDP medium term if those deficits are funding structural reform. However, under the
proposals, this should only take place for those states where the sustainability of the
public finances will not be undermined. Essentially this is defined as where the debt
to GDP ratio is below 60%. The introduction of the debt to GDP criteria explicitly
into the SGP assessment framework will prove key for some member states.
Notably, as the Chart 10 below shows, Italy, Greece and Belgium all have debt
ratios over 100% of GDP.
Chart 10: Debt to GDP high in Italy, Greece and Belgium Chart 11: Cyclically adjusted deficit deteriorated during 2000-02
120 15
% of GDP, 2002 European Commission Estimates EUR Bn Change in structural budget balances 2000 to 2002
10
100 Fiscal consolidation
General Government Gross Debt 60% Debt criteria level 5
80 0
-5
60
-10
40 -15
Fiscal slippage
-20
20
-25
0 -30
y
d
ds
ain
um
d
ce
e
ia
al
ly
an
lan
lan
nc
Ita
str
g
n
ee
Sp
-35
rtu
lgi
rm
rla
a
Ire
Fin
Au
Gr
Fr
Be
Po
the
Ge
ES B I A P FIN GR NL IR F EU12 BD
Ne
Source: UBS Warburg, European Commission Estimates Source: UBS Warburg, European Commission Estimates
Proposed SGP changes do

Critically, these proposals do not alter the SGP to the extent that increased deficit
not change fiscal outlook in
spending is currently possible for Germany, France or Italy. Nominal deficits in
key economies
each of these economies (which together account for 69.9% of euro area GDP) are
either above or close to the 3.0% of GDP reference value. With the European
Commission forecasting a deficit of 3.8% of GDP in 2002, the pressure on
Germany to reduce its budget deficit remains as strong as ever. Additionally, these
proposals would, if adopted, not lessen the pressure on France and Germany to
tighten policy given the deterioration in the cyclically adjusted deficit indicated in
Chart 11 above. Finally, the introduction of the debt criteria explicitly into the SGP
assessment should increase the pressure on Italy to act to reduce its deficit.
27 UBS Warburg
Incentives to follow SGP While these proposals do change when the Commission might act to highlight
framework have not budgetary slippage or divergence from a Member States published budgetary
improved plans, they do not alter the incentive structure for Member States to abide by
Commission recommendations. The mechanism by which pressure is applied on
Member States remains essentially via peer pressure at the heads of state and
finance minister level. The ultimate threat of sanctions in the form of a fine
continues to exist in the event of continued budgetary slippage and unsatisfactory
correction attempts. However, this threat remains hollow because of the high level
political involvement at every key stage of the excessive deficit procedure. As a
result, we do not expect the current deficit situation to result in fines on any
member state especially Germany. Nevertheless, pressure to correct deficit
slippage from the Commission and the ECB will continue in coming months. These
proposals, if ratified by member states, will probably act to increase the level of
rhetoric from the European Commission on Member States deficits.
This will not be the last The proposed change to the SGP would introduce a sensible degree of flexibility
revision to the euro areas into the euro areas policy framework. However, the incentives and logic for
policy framework Member States to comply with that framework remain unchanged. It is not clear, in
our view, that these proposals will substantially change Member States fiscal
policy behaviour going forward or that they would have prevented the recent deficit
slippage. As Pedro Solbes said when presenting the proposals, to a large degree in
EMU we have a learning by doing process. This was not the first step in refining
the euro areas policy framework and we do not think it will be the last.
Table 3: Key euro area member state debt and deficit data (European Commission estimates)
2002 EC estimates Share of euro area GDP Nominal deficit (% GDP) Cyclically adjusted deficit (% GDP) Debt (% GDP)
Germany 29.8% 3.8 3.3 60.9
France 20.5% 2.7 2.7 58.6
Italy 19.6% 2.4 1.8 110.3
Spain 10.2% 0.0 0.1 55.0
Netherlands 5.6% 0.8 0.6 51.0
Belgium 3.8% 0.1 -0.2 105.6
Austria 2.9% 1.8 1.6 63.2
Portugal 2.3% 3.4 3.0 57.4
Greece 2.3% 1.3 1.7 105.8
Finland 1.6% -3.6 -3.7 42.4
Ireland 1.1% 1.0 1.4 35.3
Source: UBS Warburg, European Commission Estimates
Analysing fiscal policy sustainability
The primary objective of the SGP is to ensure that public finances remain on a
whose primary aim is to
sustainable footing or to ensure stable or declining debt to GDP ratios. However, as
ensure fiscal sustainability
we show below, this long-term sustainability requirement does not necessarily
require government budgets to be in surplus, or even in balance.
The primary balance is defined as the budget balance excluding debt service (ie the
interest payments on public debt). If we denote the primary balance for year t by Pt,
28 UBS Warburg
the level of debt during this year by Dt and the average interest rate on the debt by r,
then the increase in the level of debt is described by the following equation:
Dt+1 = (1+r) Dt + Pt
Hence the increase in the debt/GDP ratio (dt+1) depends on the budget deficit/GDP
(pt) ratio and the growth rate of GDP (gt). The above equation becomes:
dt+1 = (1+r) dt + pt - gt
How does one interpret this equation? The higher the interest paid by the
government, the higher the governments initial debt/GDP ratio or the higher its
Debt sustainability does not primary deficit, the bigger the increase in the debt/GDP ratio will be. But these
necessarily require effects are countered to some extent by the rate of growth of nominal GDP. Beyond
Governments to run budget this mathematical concept, the economic mechanism is that the increase in the
surpluses debt/GDP ratio depends on the difference between the fluctuations of debt and
nominal GDP. If GDP is growing more quickly than the increase in debt, then the
debt/GDP ratio will fall. This implies that a government running a reasonable
deficit in a growing economy can still manage to reduce its debt to GDP ratio.
If we apply this approach to the euro area, we find that public finances appear
sustainable in the long term despite the fact that the euro area was running a budget
deficit in 2001.
Reasonable assumptions In 2001, the primary surplus was 2.5% and the headline deficit was 1.4%. Hence
show euro area public debt service accounted for 3.9% of GDP in 2001. With debt at 69.2% of GDP, this
finances are sustainable also means that the apparent interest rate paid by the governments was 5.6% (ie
3.9/0.692). Using these numbers, and assuming that money GDP growth will be at
4.0% (2.5% real growth and 1.5% inflation) we can make some back of the
envelope projections for the debt/GDP ratio in the euro area. These are shown in
Chart 12 and suggest a slowly declining debt/GDP ratio.
What level of deficit is consistent with a declining debt/GDP ratio? Our debt
dynamics equation above can be re-arranged to show that a given a level of primary
deficit, pt = gt - (1+r) dt will stabilise the debt/GDP ratio. This is the minimum
deficit (or surplus) needed to have a credible budgetary policy. The equation shows
that the primary balance needs to be higher if the debt/GDP ratio or the interest rate
is high, but can be lower if growth is high. Chart 14 shows our calculations of the
gap between actual primary balances and those that would stabilise debt/GDP ratios
in each of the EU12 member states in 2001.
with most economies

Our calculations suggest that the Member States can be split into three groups. The
erring on the side of caution
first, Netherlands, Spain, Ireland and Finland combine already low debt burdens
with larger-than-necessary primary surpluses. The second group, Italy, Belgium and
Greece are also exceeding the surpluses required to stabilise debt, but start from a
much less favourable position. The third group, Germany France, Portugal and
Austria, have debt levels that are close to 60% of GDP but are doing the bare
minimum, or in some cases less than the bare minimum required to stabilise debt at
these levels.
29 UBS Warburg
Fiscal sustainability the evidence
Chart 12: In aggregate, euro area fiscal policy is sustainable Chart 13: Apparent interest rates still vary across the EU12
80
% Debt to GDP ratio, Actual Netherlands
Debt to GDP ratio, Simulation * Finland
75
Belgium
70
Greece
65
Italy
Portugal
60 Euro zone
France
55
Germany
50 Luxembourg
Austria
45
Spain
40 Ireland
1990 1995 2000 2005 2010
4.0 4.5 5.0 5.5 6.0 6.5
* with 4% money GDP growth and primary surplus stable at 2.5%
Apparent interest rate on public debt
Source: Datastream, UBS Warburg Source: Datastream, UBS Warburg
Chart 14: Most member states are erring on the safe side Chart 15: Debt has fallen as the primary surplus has risen
120 80 5
% Debt to GDP ratio (Lhs.)
IT BE Primary surplus (Rhs.) %
GR
100 75 4
80
Debt to GDP ratio
70 3
AU
GE 60 FR 65 2
SP
PO NL
FN
40 60 1
IR
20 55 0
LX
0 50 -1
-4 -2 0 2 4 6 8 10 91 92 93 94 95 96 97 98 99 00 01
Difference between actual (excl. UMTS) and stabilising primary balances
Chart 16: Four member states debt levels are over 60% of GDP Chart 17: Three member states account for 75% of public debt
140% Finland
Portugal Ireland
Government debt Austria
1%
1%
1%
Luxembourg
(as a % of GDP) Greece 3% 0%
120% 3%
Netherlands Italy
5% 28%
100% Belgium
1996 2001 6%
80%
Spain
60% 8%
40%
20%
France
0% 18%
Germany
rg
y
ia
ce
al
ly
d
s
ain
um
ce
d
an
nd
lan
lan
Ita
str
ou
an
26%
ee
rtu
Sp
lgi
rm
rla
Au
Ire
mb
Fin
Fr
Gr
Be
Po
the
Ge
xe
Ne
Lu
30 UBS Warburg
One other key tool commonly used to analyse fiscal policy is the structural
The structural budget strips budget, also known as cyclically adjusted budget. This is an attempt to separately
out the influence of the identify the impact of the economic cycle and discretionary changes in tax and
economic cycle spending policy on the public finances. The structural budget deficit, or rather its
year-by-year change, is often used as a measure of the fiscal stance, with a rise in
the structural budget deficit signalling a looser fiscal stance.
It is generally agreed that the expenditure side of the public finances is relatively
immune to growth, the main impact being on unemployment benefits. As a rule of
thumb, it is reckoned that one percentage point increase in GDP growth reduces
public expenditure by around 0.1% of GDP. This figure obviously varies
significantly from one country to the other depending to a large extent on the
generosity of the unemployment benefit system.
However, the revenue side is more sensitive to the economic cycle. It is commonly
agreed that the elasticity of total public revenues to GDP growth is close to 100%:
for instance, consumption that is 1% higher than expected will increase VAT
receipts by about 1% as well. However, it is important to note that, even with an
elasticity of 100%, the impact can be lagged: corporate taxes are paid on the
previous years profits, hence higher growth during a given year will show in higher
tax receipts during the following year.
As a rule of thumb, a 1ppt Overall, a one-percentage point additional increase in GDP will thus imply an
rise in growth reduces the increase in government revenues of around 1% of GDP. But because total public
deficit by 0.5% of GDP receipts account for less than 50% of GDP, the budget balance will improve by less
than 0.5% of GDP. Adding the small contribution from lower public spending, it is
fair to estimate that a one-percentage point additional increase in GDP growth
improves the government budget balance by about 0.5% of GDP.
The structural deficit is then defined as the deficit that would prevail with normal
growth conditions. In the euro area, trend growth is usually estimated in the region
of 2.5%, hence if growth is at 1.5% (one percentage point below its trend), the
structural deficit will be 0.5% smaller than the headline budget deficit.
The role of debt

Debt levels have been The original excessive deficit procedure in the Maastricht Treaty treated the level of
allowed to become a debt to GDP ratios and the general government budget balances equally. In other
secondary concern in recent words, a Member State could be found to have an excessive deficit if either its
years general government financial deficit exceeded 3% of GDP, or if its general
government debt ratio exceeded 60% of GDP. But since the inception of the
Stability and Growth Pact in 1999, attention has become much more focused on the
deficit criteria, with debt considerations a secondary concern. As Chart 16 shows,
progress in reducing debt levels in the euro area since 1996 has been limited. In
2001, four member states had debt levels that were in excess of 60% of GDP and
three member states debt ratios exceeded 100% of GDP.
although the Commission However, there are signs that all this may be about to change. The latest European
is trying to reverse this Commission proposals for improving the application of the Stability and Growth
process Pact have yet to be approved by European Ministers a process that is unlikely to
happen before Spring 2003. Yet it is clear that if the European Commission
proposals are approved, then debt, as well as deficits, is likely to move firmly back
into the mainstream of the fiscal policy process.
31 UBS Warburg
Why privatisation proceeds dont affect the

budget deficit
The principle is simple: not all financial operations are taken into account when
calculating the public deficit. For instance, a privatisation operation will appear in
the financial account. A net cash payment will be paid to the government but the
public sector will lose its stake in the privatised company. These two elements will
cancel each other out, hence the wealth of the public sector will remain unchanged.
In that case, there is no impact on the deficit according to the Maastricht treaty.
A nationalisation, be it partial or full, should be treated the same way: the cash
payment from the public sector will have a counterpart (the stake received) and will
not affect the Maastricht deficit. This rule would also apply, for instance, if the
government was to buy part of the debt of a private company or recapitalise it or if
the public sector was to exchange one of its assets for cash (ie a securitisation).
Detailed rules are more complex and situations are often more borderline. In
borderline cases, Eurostat has to decide what is the appropriate accounting practice.
Readers interested in the details should refer to ESA manual on government deficit
and debt published by Eurostat. (IS SN 92-894-3231-4).
Italy has provided the most recent example of a financial operation that was not
allowed to feed through into a lower budget deficit. During the summer of 2002,
Italy argued that the securitisation of real estate helped reduce the deficit by 0.3%
last year and the securitisation of lottery revenue by almost the same amount. But
this accounting treatment had to be confirmed by Eurostat. Finally, it was decided
to remove all the receipts from securitisation, hence the deficit was increased by
0.56%. The Italian stability programme was forecasting a 1.1% deficit for 2001,
then upgraded to 1.4% so the cancellation of the securitisation operations pushed
the deficit to 2.0%.
The reason for this rule is also simple. The objective was to remove privatisation
receipts or any one-off payments from the public sector revenue. The fear was that
countries would implement privatisation in order to meet the Maastricht criteria ie
relying on one-off measures rather than genuine structural adjustments.
This means that financial operations obviously affect the cash deficit but have no
impact on the Maastricht definition of the deficit. But the debt level is still affected.
If we go back to the Italian example, the reclassification of the 2001 securitisation
receipt, worth 0.56% of GDP, means that this securitisation has no impact on the
Maastricht deficit. But the upfront payment means that the cash deficit will fall by
the same amount and this will show up in the debt to GDP ratio.
32 UBS Warburg
Section 2: The data
33 UBS Warburg
Euro Area Data Decoder March 2003 PRICES
Chapter 3: Prices
The Harmonised Index of Consumer price indices measure the result of the interaction of supply and demand
Consumer Prices (HICP) is on the high street a function of the interaction of supply and demand in the rest of
the most widely watched the domestic and international economy. These latter are measured by indicators
price index in the euro area such as producer price indices (PPI) as well as wholesale export and import prices.
However, because the Harmonised Index of Consumer Prices or HICP is at the
centre of the ECBs policy framework, other indicators of inflation are important
for financial markets and policy makers only to the extent that they provide a guide
to the likely future developments in the HICP.
Ensuring price stability is the ECBs primary objective. The ECB has defined price
stability as a year-on-year increase in the HICP for the euro area of below 2%,
with the provision that price stability according to this definition be maintained
over the medium term. It is for this reason that the headline HICP and not a subset
or core measure is the key macroeconomic variable over time for the ECB and the
variable by which the ECB expects itself to be judged. We focus on the HICP
index, its preliminary estimates and the national CPI data on pages 37 to 43.
thanks to its role at centre The ECB has chosen to target inflation in the medium term because of the lags
of the ECBs monetary policy between the implementation of changes in monetary policy and their effect on
objective activity and inflation. The ECB has not defined the concept of the medium term
precisely but it is widely perceived to be in the region of 18-24 months from the
present. As a result, data on current HICP inflation is only important insofar as it
acts as a starting point and influences inflation expectations, which, in turn, impact
inflation in the medium term through firms pricing decisions and wage bargaining.
Economic theory tells us that the price of goods and services is determined by the
interaction of supply and demand. The price level of goods and services should, in a
free market, be the price at which the supply for those goods and services equals the
demand. Prices will rise if the supply of goods is not sufficient to satisfy demand (ie
there is excess demand) while prices should fall if there is excess supply. This
simple result is a function of a complex series of interactions that determine supply
and demand at many levels of the production chain across the economy.
Chart 18: The output gap and HICP inflation Chart 19: Euro area PPI inflation and the HICP
16 12
Euro area output gap, % GDP (OECD calculation) Euro area consumer price inflation % yoy
14
12 9
10
6
8
6
3
4
2
0
0
-2 -3
-4 Euro area HICP inflation (rhs) Euro area PPI (industry ex-construction) inflation
61
63
65
67
69
71
73
75
77
79
81
83
85
87
89
91
93
95
97
99
01
-6
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
Source: UBS Warburg, Datastream, OECD Source: UBS Warburg, Datastream, Eurostat
34 UBS Warburg
Analysing and forecasting

When looking at the economy in aggregate, broad measures of demand relative to
inflation requires an
the economys ability to supply (such as the output gap, see Chart 18 above) can be
used to judge the degree of inflationary pressure in the economy. However, because
assessment of capacity
measuring the output gap on a timely or accurate basis is fraught with difficulty,
pressures
policy makers and financial markets also consider narrower indicators of supply
chain price pressures.
as well as pipeline prices Of these other indicators, PPI inflation and survey data are featured on pages 44 to
pressures 47. However, these indicators focus on individual sectors of the economy and
therefore give only a partial picture of inflation pressures. Chart 19 shows the loose
relationship between PPI inflation and HICP inflation. As a result, taken in
isolation, these indicators are not important for financial markets and policy makers
but do become more significant when taken together.
In addition to focusing on indicators of excess demand in the supply chain as a

guide to the likely developments in HICP inflation, the ECB also gives the supply
of money a prominent role in its analysis. This is because the supply of money is, in
the long run, linked to the price level in the economy by the following identity.
M = Yr + P - V
Where P is inflation;
Yr is real GDP growth;
M is money supply growth, and
V is the change in the velocity of money
In the medium-term, the ECB The above equation essentially says that the nominal value of all the goods in the
believes the money supply is economy (price multiplied by output) is equal to the supply of money multiplied by
an important determinant of the number of times that supply of money is used in a given time period (the
inflation velocity of money). This relationship is an identity in other words it must hold
true. But while the right-hand side of the equation is relatively stable in
composition, the composition of the left-hand side of the equation can change
relatively significantly over time. The implication is that while the money supply is
a fundamental determinant of the price level in the long term, in the short term its
importance is limited because of the potential for the velocity of money to change.
Chart 20: Velocity of money supply growth varies over time Chart 21: Excess M3 growth captures broad inflation trends
14 12
% yoy % yoy Growth in M3 over that required to match real GDP growth
12 Consumer price inflation
GDP growth Price inflation Implied velocity (V = Y*P/M) growth M3 growth 10
10
8
8
6 6
4 4
2
2
0
0
-2
-4 -2
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Source: UBS Warburg, Datastream, ECB Source: UBS Warburg, Datastream, ECB
35 UBS Warburg
Chart 20 shows the rate of growth in the M3 money decomposed according to the
above identity. The implied rate of growth in the velocity of the money supply
(which has been calculated from the growth in M3, prices and GDP) is volatile over
time but appears to revert to the mean. The implication is that, if the growth
velocity of money is indeed mean reverting, a trend acceleration in M3 growth over
and above that required to match real GDP growth for a period of time would be
consistent with accelerating consumer price inflation. However, the volatility of the
growth in the velocity of money means that significant temporary increases in M3
growth need not result in higher inflation. Chart 21 further highlights this point by
showing consumer price inflation relative to money supply growth in excess of that
required to match real GDP growth since 1981.
In recent months, however, The breakdown in the linkage between money growth and inflation since 2000 is
the ECB has downplayed the likely to be a function of portfolio reallocations during a period of falling stock
importance of this link markets. The ECBs belief that, in a weak economic growth environment a high rate
of money supply growth as a result of portfolio reallocations would not be
inflationary, led to a downplaying of the influence of M3 variable. The slowdown in
credit growth during this period served to support this view. However, that is not to
say M3 growth will not become important for policy again.
36 UBS Warburg
Harmonised Index of Consumer Prices (HICP)

Overview Harmonised Index of Consumer Prices
Published by: Eurostat Series starts Jan 1990
Frequency: Monthly Market importance High
Normal publication date: Third week of month Market focus Headline inflation rate
Normal publication lag: 3 weeks Key transformation % yoy
Coverage: EU12, Member States
Source: UBS Warburg
Description The Harmonised Index of Consumer Prices (HICP) is constructed in each member
state of the EU to facilitate international comparisons of consumer price inflation.
The HICPs were initially developed to aid in deciding whether the aspirant
member states met the convergence criteria for EMU on price stability.
Currently euro area HICPs are used by the ECB to analyse price developments
Table 4: HICP country weights across the euro area on a consistent basis. But they will also be used to judge
2002 Per 1000 convergence progress for prospective new members in the future. As noted above, a
Germany 306
year-on-year rate of increase in the euro area HICP of below 2% has been adopted
France 204
by the ECB as its definition of price stability.
Italy 192
The euro area HICP is a weighted aggregate of the national HICPs. The national
Spain 104
HICPs are each a weighted aggregation of 12 component indices which, in turn, are
Netherlands 52
calculated from more than 90 sub-indices. The 12 component indices are based on
Belgium 34
the same set of information across countries but are weighted differently depending
Austria 32 on the national spending patterns in the economy in question.
Greece 25
Portugal 20 The weight given to each country in the EU12 aggregation is derived from its share
Finland 16 in total euro area private consumption, as calculated in the National Accounts.
Ireland 13 These country weights are adjusted in January each year. However, due to the
Luxembourg 3 delays in obtaining the National Accounts data, the weights for any given year (t)
are based on National Accounts data for two years earlier (t-2). The weights of
Source: Eurostat
individual goods and services for each countys HICP are derived from detailed
national surveys of consumer spending habits, which are also updated annually.
Chart 22: Weights of euro area HICP sub-components Chart 23: Alternative breakdown and euro area HICP weights
18% 16.4%
16% 15.2% 15.0%
14% Services (overall

Energy
12% Food including index excluding
alcohol and 8.6% goods)
9.5%
10% 9.0%
8.0% 7.9% 7.7% tobacco 38.9%
8%
20.4%
6%
4.0% 3.9%
4% 2.5%
2% 0.9%
0%
Furnishings, household equipment and routine
Housing, water, electricity, gas and other fuels
Food and non-alcoholic beverages
Restaurants and hotels
Clothing and footwear

Recreation and culture
Alcoholic beverages, tobacco and narcotics
Health
Education
Transport
Miscellaneous goods and services
Communications
maintenance of the house
Non-energy
industrial goods
32.1%
Source: UBS Warburg, Eurostat. Total = 100% Source: UBS Warburg, Eurostat. Total = 100%
37 UBS Warburg
The HICP is also commonly broken into four broader component indices under the
headings; food, energy, non-energy goods and services, which are perhaps easier to
understand than the less intuitive 12 component indices mentioned above. Food and
energy price inflation have, in the past, proved more susceptible to temporary
shocks and are stripped out of the headline inflation index to form a measure of core
inflation. The core rate of inflation includes non-energy goods and services and is
equivalent to 70.5% of the HICP index.
However, while the core rate of inflation is instructive about the trend in underlying
inflation, deviations from core inflation can be both significant and persistent.
Recent years have seen substantial shocks to HICP price inflation from both energy
prices and food prices. At its height, energy prices added 1.4% to headline price
inflation and food prices added 1.2%. This compares with an average contribution
of 0.3% and 0.1% respectively in the 1996-1999 period.
Inflation differentials within the euro area
National inflation rates across the euro area differ substantially and persistently.
HICP inflation rates in Spain, Portugal and Ireland have been on average 1.1%
higher than the euro area average while France and Germany have had inflation on
average 0.5% below. This differential has been driven partly because of the
pressure on tradable goods prices to converge across the euro area but also because
of the relative growth rates in demand in the respective economies. This differential
is likely to persist going forward although, with the EMU convergence dynamic
playing less in the favour of the high inflation countries, divergence could lessen
slightly.
While inflation has persistently differed across economies, it has also differed
across components. The non-energy goods prices component of the HICP has
persistently, in every euro area economy, risen less than the service price
component. This differential is due in part to relative productivity and competitive
pressures and is also likely to persist in coming years.
Chart 24: Average national HICP inflation rates Chart 25: Euro area goods and services price inflation
5.0 7.0
% yoy
4.5
6.0
4.0 Euro area non-energy industrial goods price inflation
1996-2002 average Euro area average over 1996-2002 period Euro area services price inflation
3.5
5.0
3.0
2.5 4.0
Distortion from introduction of sales prices
2.0 in selected national series
3.0
1.5
1.0 2.0
0.5
1.0
0.0
y
d
s
ain
um
e
ia
e
l
ly
ga
an
nd
lan
ec
lan
c
Ita
str
an
Sp
0.0
rtu
lgi
rm
rla
e
Ire
Fin
Au
Gr
Fr
Be
Po
the
Ge
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Ne
Source: Eurostat Source: Eurostat
38 UBS Warburg
Methodology The HICPs and CPIs are produced and published monthly and are not seasonally
adjusted. The first monthly estimates of the HICP were produced in January 1997,
with all member states providing back data to January 1996 so that inflation data
can be calculated from January 1997. In some, but not all member states, and for
some , but not all sub-components, the data has subsequently been extended back to
1990 or earlier allowing a longer run of consistent inflation figures to be calculated.
The HICPs are different from the CPIs in terms of their construction but do share
significant similarities. In particular, the actual underlying price data used in the
HICPs is usually, for reasons of practicality and economy the same as that used in
the national CPIs.
When the HICPs were initially calculated, for reasons of comparability, several
significant items were excluded. These included owner-occupied housing costs,
insurance and health and educational goods and services. Over time some of these
and other items have been added into the HICP. One of the most recent definitional
changes was the introduction of sales prices into the price data for selected
countries. Such additions occur usually in January and can create distortions in the
annual rate of inflation, either in historic or current rates. Importantly, the HICP is
viewed by the ECB as an entity, regardless of the changing underlying components
over time.
Owner-occupiers shelter costs, where expressed as imputed rents or mortgage

interest payments, are not regarded as part of the inflation process and hence are
excluded from the HICP. The different treatment of owner-occupier housing costs
is the perhaps the single key difference between national CPIs and HICPs.
Table 5 below highlights the different treatments. Clearly most national CPIs, as
with the HICP, exclude owner occupied housing costs altogether. Germany and the
Netherlands impute the impact on the price of the households consumption basket
from the rents a household would have paid.
Table 5: Summary of approaches in treatment of owner-occupied housing
Excluded from the CPI Imputed actual rent Cost of consumption Other methodology
Germany X
France X
Italy X
Spain X
Netherlands X
Belgium X
Austria X*
Greece X
Portugal X
Finland X
Ireland X**
Luxembourg X
Source: OECD; * housing construction costs only **Mortgage interest costs only
39 UBS Warburg
Chart 26: Weights of key items in euro area HICP index (2002)
Food 15.0%
Operation of personal transport 8.0%
Catering services 7.4%
Clothing 6.4%
Rentals 5.8%
Purchase of vehicles 5.0%
Electricity, gas & other fuels 5.0%
Furniture & carpets 3.2%
Personal care 2.8%
Water, refuse, sererage services 2.6%
Recreational & cultural services 2.5%
Tobacco 2.3%
Telephone, fax - equipment & services 2.3%
Transport services 2.2%
Newspapers & books 2.1%
Goods & services for routine h/hold maint 1.8%
Other recreational items 1.8%
Alcohol 1.7%
Out-patient services 1.7%
House maintenance & repair 1.6%
Footwear - including repair 1.6%
Insurance 1.6%
Accommodation services 1.6%
Medical products appliances & equipment 1.6%
Audio-visual, photography & computing 1.6%
Non-alcoholic beverages 1.4%
Package holidays 1.2%
Household appliances 1.2%
Personal effects nec 1.1%
Education 0.9%
Social protection 0.9%
Other services nec 0.9%
Household textiles 0.7%
Hospital services 0.7%
Glassware, tableware and utensils 0.6%
Financial services nec 0.5%
Tools & equipment 0.5%
Other major durables for recr'n & culture 0.3%
Postal services 0.2%
0% 2% 4% 6% 8% 10% 12% 14% 16%
Source: UBS Warburg, Datastream, Total = 100%
40 UBS Warburg
National Consumer Price Indices (CPIs)

Description Although not a policy variable focused on by the ECB, some national Consumer
Price Indices (CPIs) remain important because they are released ahead of the euro
area HICP index. In particular, this is true of the Italian and German data, the
preliminary releases of which are used, in combination with other variables, to
calculate a flash estimate of euro area HICP inflation (see below).
National CPIs retain some significance at the national level as the variable on which
wage agreements and national inflation indexation (eg, for pensions) tend to be
based. However, this role has shown signs of diminishing as the HICPs become
more established.
All EU12 member states produce national CPI figures on a monthly basis. The table
below shows the national CPIs in order of release, along with the weight of the
country within the HICP index and the correlation of the data with euro area HICP
inflation. The relatively high level of correlation, their weight within the euro area
HICP index and the timing of their release means that the German and Italian
preliminary figures stand out as the most important in the eyes of the market.
Table 6: National CPI data and euro area HICP data in order of release
Country Normal publication date* Country weight Correlation with Market

in HICP euro area HICP importance
Italy Cities: fourth week of same month High
Prel: final week of same month 19.2% 0.68 Low
Final: 14-17 of following month Low
Germany Prel: final week of same month High
30.6% 0.79
Final: third week of following month Low
Belgium Final week of same month 3.4% 0.88 Low
Euro area Flash est: final week of same month 100% High
Netherlands Second week of following month 5.2% 0.59 Low
Greece Second week of following month 3.2% 0.26 Low
Ireland Second week of following month 1.3% 0.66 Low
France Prel: 11-14 of following month
20.4% 0.93 Low
Final: 23-26 of following month
Spain Second week of following month 10.4% 0.84 Low
Portugal Second week of following month 2.1% 0.59 Low
Finland Second week of following month 1.6% 0.50 Low
Austria Second half of following month 2.5% 0.86 Low
Euro area Final: third week of following month 100% 1.00 High
Source: IMF, Datastream, UBS Warburg; * Releases typically a week later; ** Final release only for December data
The Italian cities CPI data is usually the first piece of consumer price inflation to
become available in the euro area. The CPI inflation rates for the 12 Italian cities
are released at 11:30 in the morning usually between days 20 and 24 of the month
that the data refers to. The focus of the release is the average month-on-month
change in the individual cities indices which is then translated into a preliminary
estimate of the national CPI. There is no official estimate of the aggregate rate of
41 UBS Warburg
Italian price inflation to accompany the city data (this is made available with the
preliminary data release a week later) but an unofficial economists estimate is
usually published on the wires within two to three minutes of the cities data
release.
The German States CPI data is usually released over the course of two to three
days. Once all states data has been released, an official preliminary national
inflation number is usually released within hours. As with the Italian Cities CPI
data, the monthly change in the States CPIs is focused on as a guide to the
preliminary CPI estimate.
Chart 27: Release schedule for euro area CPI and HICP data
Euro area HICP
Austria CPI Flash estimate
Finland CPI Final releases
Portugal CPI
Spain CPI
France CPI
Ireland CPI German states and

Greece CPI preliminary CPI
Netherlands CPI
Italian cities CPI
Belgium CPI
Germany CPI
Italy CPI Preliminary releases
-15 -10 -5 0 5 10 15 20 25 30
Days from end of reference period
Source: UBS Warburg, Datastream
Methodology All national CPI data is released monthly and within one month of the end of the
reference period as shown in the above chart. Headline National CPI data is non-
seasonally adjusted.
There are important distinctions between member states methods of CPI calculation
hence the publication of the harmonised data. The basket of goods and services
covered varies between national series as do the breadth of collection and the
frequency of data collection for certain items. For example, the German national
CPI consists of roughly 350,000 price quotations spread over 750 items from
20,000 outlets every month. By contrast, the Austrian CPI consists of 40,000 prices
collected for 812 items in some 4,000 outlets in the 20 largest cities.
A further important difference is the definition of core inflation presented in the

statistical data releases. While many national data releases do not specify a core
inflation measure, the national Spanish inflation release defines core inflation as
headline ex energy and seasonal food (82.3% of the index). Using a separate
methodology, the French statistical office publishes a measure of underlying
inflation excluding volatile items, which amounts to 61.7% of the headline index.
42 UBS Warburg
HICP Flash Estimate

Overview Eurostat Flash estimate of euro area HICP inflation
Published by: Eurostat Series starts October 2001
Normal publication date: Last week of month Market focus Annual inflation rate
Normal publication lag: Before end of same month Key transformation % yoy
Coverage: Euro area
Source: UBS Warburg
Description First published for October 2001, the flash estimate of euro area inflation is
published well in advance (around the end of the month) of the full release (which
is published around the 18th day of the following month).
The flash estimate release provides only a provisional figure for the headline rate of
inflation with no detail as to the breakdown of inflation either by component or
across countries. Over the two years to November 2002, the flash estimate has 14
times correctly anticipated the full estimate, eight times differed by 0.1 percentage
point and twice differed by 0.2 percentage points, the last time in April 2002.
However, a major structural change such as the introduction of the euro is likely to
affect the performance of the estimation procedure. Thus the flash estimate may
carry a greater uncertainty going forward than past performance would indicate.
Methodology To compute the flash estimate of euro area HICP inflation, Eurostat uses early price
information relating to the reference month issued at present by Germany, Italy and,
if available, by other Member States, as well as early information about energy
prices. This data amounts to over 50% of the weight of the information included in
the full HICP.
The estimation procedure uses regression and time series modelling to combine
historic information with information on recent price developments to generate an
estimate (essentially an official forecast) of euro area HICP inflation. Because the
available data for the estimation process varies from month to month, and because
structural developments may alter the relationships between variables, the
estimation process used by Eurostat is flexible, undergoes regular maintenance and
may be adjusted at any time to allow for changes identified in its underlying
assumptions.
43 UBS Warburg
Producer Price Indices (PPI)

Overview Producer Price Indices, national and euro area
Eurostat and national Eurostat: 1990
Published by: Series starts
agencies National: varies
Frequency: Monthly Market importance Low
Normal publication date: Varies Market focus Headline index
Normal publication lag: Varies Key transformation % yoy
Coverage: Euro area and national
Source: UBS Warburg
Description Consumer Price Indices (CPIs) are designed to measure changes over time in the
average retail price of a fixed basket of goods and services taken as representing the
consumption habits of households. By contrast, Producer Price Indices (PPIs)
normally provide measures of average movements of prices received by
manufacturers selling to domestic markets. PPIs therefore present a picture of
adjustment processes and possible bottlenecks in different branches of the economy.
The term PPI is most commonly used to refer to an index of output prices. They
reflect factory gate prices, valued at basic prices, or the prices received by the
producer at the first stage of commercialisation. PPIs are not a measure of average
price levels or a measure of the costs of production, nor do they include commercial
mark-ups. They also exclude transport costs and consumption taxes.
Methodology As with CPIs, producer price data is collected by national statistical agencies to
produce national PPIs. The data is then aggregated at the euro area level by
Eurostat. Neither the euro area nor national PPIs are seasonally adjusted.
The euro area PPI is constructed using domestic market data only and includes all
duties and taxes except VAT. Export price data is available and included within
some national PPI data but not the EU12 aggregate.
Table 7 highlights which National Statistical offices publish export price indices
with their PPI indices and which PPI indices include export prices. This is
important, as it is the main reason why Dutch PPI inflation is more volatile than PPI
inflation in other member states.
Chart 28: PPI more volatile than HICP Chart 29: Euro area PPI inflation by main component
115 8.0 30.0
Index % yoy Intermediate goods (lhs) Capital goods (lhs) % yoy
Durable consumer goods (lhs) Non-durable consumer goods (lhs) 25.0
110 Energy (rhs)
6.0
20.0
105
4.0 15.0
100
10.0
2.0
95
5.0
90 0.0 0.0
Euro area HICP Euro area PPI
-5.0
85
-2.0
-10.0
80
-4.0 -15.0
90
91
92
93
94
95
96
97
98
99
00
01
02
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
44 UBS Warburg
Notably, the German PPI excludes import prices and for this reason, developments
in this index can lag those of other euro area countries if imported input goods
prices (such as oil prices) are driving changes in PPI inflation in those countries.
The German statistics office produces measures of import prices, which are released
30-35 days after the end of the reference month. They also produce a wholesale
price index. This includes both imported and domestically produced goods and is
therefore better correlated with euro area PPI inflation. This wholesale price index
is released 13-17 days after the reference month. The German PPI is released 17-21
days after the reference month. In the context of the euro area inflation outlook, PPI
inflation indicators are regarded as of low importance by financial markets. Despite
national methodological differences, the initial releases of the national data can give
a good indication of the aggregate euro area PPI index. Chart 30 highlights the
relative release times.
Table 7: PPIs Inclusion of exports Chart 30: Normal release times for PPI data
Publish dom Publish export Include exports euro area

market PPI market PPI in total Greece
Germany Yes No No Portugal
France .. .. .. Italy
Italy Yes No No Netherlands
PPI
Spain Yes No No Spain
Netherlands Yes Yes Yes France
Belgium Yes Yes Yes Germany Wholesale

Austria .. .. Yes Belgium prices
Greece .. .. .. Ireland
Import prices
Portugal Yes No No Finland
Finland .. .. Yes Austria
Ireland No No Yes 0 5 10 15 20 25 30 35
Days fromend of reference month
Luxembourg .. .. ..
Source: OECD
Source: UBS Warburg
Chart 31: Euro area PPI component weights

18
16 .4
16
14
12
10 .3
10
8 7. 5
6. 7
6. 2 6. 1
6 5. 1 5
3. 8 3. 7
4 3. 5
3. 1
2. 8 2. 7
2. 4
2. 1
1. 7 1. 7
2 1. 6 1. 5 1. 3
0. 8 0. 8 0. 8 0. 7 0. 5
0
0
n
s
ite
ls
g
es
s
ls
tic
ry
uf.
.
ls
ry
ca
o
er
te
les
cts
rt
ts
ts
od
un ng
ge
tio
er
nin
lic ter
re
ra
tin
cc
ta
ica
po
ine
ign
ine
icl
uc
uc
las
wa
ap
an
pti
hin
lo
mm thi
pr
ica
ra
du
ne
xti
eta Wa
me
rin
ba
mi
ns
eh
od
od
dp
em
ch
rm
dl
do
dp
ch
ve
eta
Co Clo
m
ro
Te
mi
ot
ac
dp
To
ra
rv
pr
pr
Ma
sic
n
leu
be
Ma
dp
/h
an
Ch
the
an
an
lm
fm
rt
la
llic
an
er
tal
to
as
Ba
he
tro
oo
d
lp
oa
e
do
ca
al
er
Mo
eta
ath
go
Me
./g
an
-m
fic
ing
Pu
Ot
dic
pe
W
bb
fc
tri
an
Le
-m
Of
ec
on
nin
V/
od
sh
ec
go
Ru
Me
ed
El
rn
No
/T
re
bli
Mi
Fo
El
fin
nin
dio
itu
he
Pu
Re
rn
Mi
Ot
Ra
Fu
Source: UBS Warburg, Eurostat. Total = 100%
45 UBS Warburg
Price Surveys
Description Surveys of price expectations and price perceptions are released in combination
with surveys of sentiment both for consumers and businesses. The surveys most
frequently looked at by the ECB are published with the Reuters purchasing
managers index (both services and manufacturing) and the European Commissions
survey of business and consumer sentiment.
Business surveys
The business sector surveys price indicators (both services and industry) tend to be
highly correlated with PPI inflation (the correlation coefficients are shown in Table
9). Table 8 highlights the availability of price data from the various business
surveys across the main sectors.
Table 8: Key business survey price indicators
Services Services Retail selling Wholesale Construction Industrial

output prices input prices prices selling prices output prices output prices
EC Survey na na na na Expectations Expectations
PMI Current Current na na na Current
Ifo business Current & Current & Current & Current &
survey Expectations Expectations Expectations Expectations
INSEE
business Expectations
survey
Source: Reuters, EC, Ifo, INSEE. Expectations = index based on forward looking survey question, Current = index based
on survey of current conditions, na = area not covered by survey.
Of the above series, the EC survey construction and industrial price indices along
with that of the French INSEE business survey are forward looking, while the
German ifo index has a forward looking price component for each sub-sector. By
contrast, the PMI survey only covers price developments in the surveyed month
relative to the previous month. Table 9 records the highest contemporaneous
correlation for each of the surveys with the headline PPI inflation rate. On this
analysis, the EC Survey of industrial sector price expectations has the highest
correlation with PPI inflation over the longest time period. The correlation of the
PMI price indicators with PPI inflation is also high, but is probably boosted because
the short history of the PMI survey coincides with a period of substantial oil price
movements, which dominated all indicators of price developments.
HICP inflation tends to be poorly correlated with business surveys of price

developments. The retail component of the German ifo institutes survey has a
relatively high correlation but is volatile on a monthly basis and only picks up
longer term trends (see Chart 33). The relatively high correlation of the French
INSEE business survey of industrial price expectations with HICP inflation is
explained by the extreme decline in price expectations during the 1990s compared
with the German and euro area business survey price components. The relatively
high correlation of the Services PMI and HICP inflation is probably a function of
the short history of the series and the dominant effect of oil prices over the course
of that short history. Both the services PMIs price components have a very low
(negative) correlation with HICP service price inflation (of 0.1 to 0.2).
46 UBS Warburg
Table 9: Contemporaneous correlation between survey indicators and inflation indicators
Correlations run from January 1991 to October 2002 Correlation with HICP Correlation with PPI
PMI Services prices charged* 0.69 0.88
French INSEE business survey selling price expectations 0.66 0.73
PMI Services input prices* 0.64 0.90
German ifo: retail trade selling price expectations 0.61 0.12
German ifo: retail trade current selling prices 0.57 0.11
German ifo: wholesale trade selling price expectations 0.48 0.48
German ifo: wholesale trade current selling prices 0.44 0.65
EC Survey: industrial sector price expectations 0.42 0.81
German ifo: construction current selling prices 0.42 0.12
German ifo: construction selling price expectations 0.42 0.16
PMI Manufacturing prices** 0.37 0.87
German ifo: manufacturing selling price expectations 0.19 0.53
EC Survey: construction sector price expectations 0.05 0.47
German ifo: manufacturing current selling prices 0.04 0.60
Source: UBS Warburg, Datastream * correlation begins in August 1998 ** correlation begins in July 1997
Consumer price surveys
The European Commission survey has two questions on consumer price

perceptions. The first asks how consumers believe that the current cost of living has
changed compared with its level 12 months ago. The second is forward looking and
asks consumers how they think prices will compare to their current level in 12
months time.
As Chart 32 shows, there has been an historically high correlation between the level
of the consumer price survey over time and the rate of HICP inflation. But this
relationship has broken down in recent months. The survey series corresponding to
past price rises suggests consumers believe prices have risen rapidly in the last 12
months. In sharp contrast to this, the forward-looking survey series suggests
consumers to expect prices to increase at a relatively slow rate. The cause of this
sharp divergence is not clear, but evidence from other surveys as well as anecdotal
evidence, suggests that the structural change and price rounding associated with the
introduction of euro notes and coins has had a role to play.
Methodology The methodology used to calculate the European Commission price series is the
same as the methodology used to calculate the activity indicators in the same EC
consumer confidence survey. Please refer to page 85 for more details on the
methodology and release times.
When the surveys containing the price data are initially reported, only the PMI and
the French INSEE business survey tend to have the price components explicitly
highlighted. The components of the German ifo are not available for a week
following the release. While the components of the EC survey are available from
the Commission website immediately after general release, they are not normally
widely commented on.
47 UBS Warburg
Chart 32: EC consumer price surveys have diverged Chart 33: Ifo retail price indicator volatile but picks up trends
80 6 80 13
% bal % yoy % bal German ifo: retail trade current selling prices (lhs) % yoy
German ifo: retail trade selling price expectations (lhs)
HICP inflation (rhs) 11
5 60
60
9
4 40
7
40
3 20 5
20 3
2 0
1
0
1 -20
EC Survey: change in cost of living over last 12 months -1
EC Survey: expected rate of change in cost of living relative to present rate of change
HICP inflation (rhs)
-20 0 -40 -3
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
Source: Eurostat, Datastream Source: ifo, Datastream
Chart 34: EC survey of industrial prices correlated with PPI Chart 35: EC survey of construction prices is less correlated
35 8 40 8
EC Survey: industrial sector price expectations (lhs) PPI (industry ex-construction) inflation (rhs) EC Survey: construction sector price expectations (lhs) PPI (industry ex-construction) inflation (rhs)
30
30
6 6
25
20 20
4 4
15
10
10 2 2
0
5
0 0
0 -10
-5
-2 -2
-20
-10
% bal % yoy % bal % yoy
-15 -4 -30 -4
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
Source: Eurostat, Datastream Source: Eurostat, Datastream
Chart 36: Price chain: ifo manufacturing price survey and PPI Chart 37: Price chain: ifo wholesale price survey and PPI
80 9 80 9
% bal German ifo: wholesale trade selling price expectations (lhs) % yoy % bal German ifo: wholesale trade selling price expectations (lhs) % yoy
German ifo: wholesale trade current selling prices (lhs) German ifo: wholesale trade current selling prices (lhs)
Euro area PPI (industry ex-construction) inflation (rhs) PPI (industry ex-construction) inflation (rhs)
60 7 60 7
40 5 40 5
20 3 20 3
0 1 0 1
-20 -1 -20 -1
-40 -3 -40 -3
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
Source: ifo, Datastream Source: ifo, Datastream
48 UBS Warburg
GDP deflators
Overview GDP deflator
Published by: Eurostat Series starts Q1 1991
Frequency: Quarterly Market importance Low
Normal publication date: Varies - 2 est of GDP
nd Market focus % yoy
Normal publication lag: 14-15 weeks Key transformation % yoy
Source: UBS Warburg
Description GDP deflators are published with the national accounts data for each economy and
the euro area in aggregate and are the broadest set of price indicators available.
However, the considerable time lags associated with the publication of the data,
together with the fact that the data are much more subject to revision than the CPIs
and HICP data, greatly reduce the usefulness to the ECB and the market impact.
The GDP deflator provides an aggregate measure over time of all the price
developments in the economy as captured by the national accounts. Deflators are
also available for the components of GDP private and public consumption,
investment expenditure, exports and imports.
Of these, the consumer expenditure deflator is most closely related to the consumer
price indices. The consumption expenditure deflator includes all domestically
produced goods and services, operating expenses of non-profit enterprises and
goods and services received in kind by individuals either from the government or
through employee benefits. By contrast, the consumer price index contains only
actual expenditure by consumers.
The export and import deflators are useful because although subject to time lags and
available only on a quarterly rather than monthly frequency, they are the only
measure of internationally traded goods and services price inflation at the national
and aggregate level. Monthly measures of traded goods price inflation are available
from the ECB but present an incomplete picture and themselves suffer from a three-
month publication lag.
Chart 38: Euro area national accounts deflators Chart 39: EU12 deflators for GDP, consumption and the HICP
135 6.0
1991Q1 =100 % yoy
130 5.0
Consumer expenditure deflator HICP inflation GDP Deflator
125 4.0
120 3.0
2.0
115
1.0
110
0.0
105
-1.0
100
Private consumption Gov't consumption Fixed investment Imports Exports -2.0
95
92
92
93
93
94
94
95
95
96
96
97
97
98
98
99
99
00
00
01
01
02
02
Q1 91 Q1 93 Q1 95 Q1 97 Q1 99 Q1 01
Q1
Q3
Q1
Q3
Q1
Q3
Q1
Q3
Q1
Q3
Q1
Q3
Q1
Q3
Q1
Q3
Q1
Q3
Q1
Q3
Q1
Q3
Source: UBS Warburg, Datastream Source: UBS Warburg, Datastream
49 UBS Warburg
M3 Money Supply
Overview M3 Money Supply
Published by: ECB Series starts January 1980
Normal publication date: Last week of month Market focus 3 month ma
Normal publication lag: 1 month Key transformation % yoy
Coverage: Euro area
Source: UBS Warburg
Description The money supply forms one of the two pillars of the current ECB monetary policy
framework. However, developments in the money supply tend to be important for
inflation developments in the longer term rather than the short term. For much of
the period since end-2000, M3 growth has been boosted by portfolio reallocations
by financial market participants. Because of this, the ECB has chosen to play down
the importance of the M3 data for much of 2002 and the importance of M3 growth
for financial markets has diminished as a result. Nevertheless, M3 is key for
monetary policy setting. In May 2001 the ECB adjusted the definition of M3 to take
account of non-euro denominated monetary assets held by euro area residents in
euro area Monetary and Financial Institutions (MFIs). This altered the historical
rate of growth in M3 and prompted a 25 bp cut in policy rates.
The ECB analyses the rate of growth in M3 relative to a reference value. This
reference value is currently 4.5% but is reviewed every December.
Economists have several definitions for the supply of money varying from a narrow
definition including notes and coins in isolation, to much broader measures
including some assets traded on financial markets. The ECB publishes three
monetary aggregates: a narrow aggregate (M1), an intermediate aggregate (M2)
and a broad aggregate (M3).
Table 10 shows the ECB definitions of the euro area monetary aggregates. These
aggregates include only positions of residents in the euro area, which are held with
MFIs located in the euro area. Holdings by euro area residents of liquid assets
denominated in foreign currency can be close substitutes for euro-denominated
assets. Therefore, the monetary aggregates include such assets if they are held with
MFIs located in the euro area.
Table 10: ECB definitions of euro area monetary aggregates
Components M1 M2 M3
Currency in circulation X X X
Overnight deposits X X X
Deposits with an agreed maturity up to 2 years X X
Deposits redeemable at a period of notice up to 3 months X X
Repurchase agreements X
Money market fund (MMF) shares/units and money market paper X
Debt securities up to 2 years X
Source: ECB
50 UBS Warburg
Narrow money (M1) includes currency, ie, banknotes and coins, as well as
balances, which can immediately be converted into currency or used for cashless
payments, ie, overnight deposits.
Intermediate money (M2) comprises narrow money (M1) and, in addition,

deposits with a maturity of up to two years and deposits redeemable at a period
of notice of up to three months. Depending on their degree of moneyness, such
deposits can be converted into components of narrow money, but in some cases
there may be restrictions involved, such as the need for advance notification,
delays, penalties or fees. The definition of M2 reflects the particular interest in
analysing and monitoring a monetary aggregate that, in addition to currency,
consists of deposits that are liquid.
Broad money (M3) comprises M2 and marketable instruments issued by the

MFI sector. Certain money market instruments, in particular, money market
fund (MMF) shares/units and money market paper, and repurchase agreements
are included in this aggregate. A high degree of liquidity and price certainty
make these instruments close substitutes for deposits. As a result of their
inclusion, M3 is less affected by substitution between various liquid asset
categories than narrower definitions of money, and is therefore more stable.
Counterparts to M3
Credit growth data is published alongside M3 data. Although initially this data
featured less prominently in the ECBs monetary analysis, credit developments
have received a higher profile following the disruptions to M3 growth resulting
from turbulence in financial markets.
The credit indicator measures credit to euro area residents from euro area based
MFIs. A breakdown of the aggregate into credit to general government and credit
to other euro area residents along with a further breakdown by credit instrument is
available in the press release. It is the credit to euro area residents excluding
government data that tends to be focused on by ECB rhetoric.
Methodology This data is collected by the ECB from euro area member state financial
institutions. A seasonally-adjusted data series is calculated for monthly comparisons
while a non-seasonally adjusted series is used for annual calculations. Because of
the volatility of the index on a monthly basis and the desire to encourage a longer
term perspective on the data, the ECB focuses on a three-month moving average.
Importantly, asset price changes can influence the value of the monetary stock. For
this reason, the rate of growth in the index focused on by financial markets is
calculated from the level of monetary flows relative to the size of the adjusted
monetary stock1 rather than the change in the level of the nominal money stock.
1
Both flows and monetary stock are adjusted for monetary asset reclassifications, other
revaluations, FX variations and any other changes that do not arise from transactions.
51 UBS Warburg
Chart 40: M3 Growth Chart 41: Growth in euro area monetary aggregates
8
%
16
7 % yoy
6
14
5 12
4 10
3
8
2
6
1
4
0
2
-1 M1 M2 M3
M3 - % mom M3 - % yoy M3 - % yoy, 3m centred moving average
0
-2
1995 1996 1997 1998 1999 2000 2001 2002 2003 1997 1998 1999 2000 2001 2002
Chart 42: Individual components of M3 Chart 43: Composition of M3 by component
40.0 6000
% yoy EUR bn
5000
20.0
4000
3000
0.0
2000
-20.0 1000
Currency in circulation (M1 component)
Overnight deposits (M1 component)
Other short term deposits (M2 component) 0
Marketable instruments (M3 component) 1998 1999 2000 2001
-40.0 Currency in circulation (M1 component) Overnight deposits (M1 component)
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Other short term deposits (M2 component) Marketable instruments (M3 component)
Chart 44: Euro area M3 and inflation the long term Chart 45: Credit growth to public and private sectors
14 12
% yoy % yoy
12
GDP growth Price inflation Implied velocity (V = Y*P/M) growth M3 growth
10
10
8 8
6
6
4
2
4
0
-2 2
Euro area M3 growth
-4 Growth in loans to euro area residents (excluding govt.)
0
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
52 UBS Warburg
Euro Area Data Decoder March 2003 WHOLE ECONOMY DATA
Chapter 4: Whole Economy Data

For policymakers, and economic commentators, obtaining a picture of
developments across the whole spectrum of economic activities is crucial.
However, obtaining such a picture is not as simple as you might imagine.
GDP data offer the best The most useful data by far, in this respect, are the Gross Domestic Product (GDP)
snapshot of activity across data. This data provides a complete picture of real (constant price) and nominal
the economy activity across the economy and allows a disaggregation of activity to be made in
one of three ways: by type of expenditure, by industry or by type of income.
Unfortunately however, the data suffers from two drawbacks. Firstly, it is only
available on a quarterly frequency. Secondly, the data is available only with a
considerable lag provisional estimates are released only some 70 days (or two-
and-a-half months) after the end of the quarter to which they relate.
but are only available In addition, the GDP data form the basis for most broad-brush measures of capacity
quarterly and with a pressures such as trend growth and the output gap. Although increasingly out of
considerable lag favour among financial market participants in the late 1990s, few policy makers
would argue that such concepts are completely redundant. A full discussion of trend
growth and the alternative ways of deriving estimates of this figure is beyond the
scope of this document. Suffice to say that most commentators put trend growth for
the euro area as a whole in the range of 2 to 2.5%.
Other indicators of whole economy activity are rare. Most leading indicators, or
surveys of business sentiment relate to activity in the industrial sector. Among those
that are discussed in the following pages are:
Higher frequency indicators The European Commissions monthly Economic Sentiment Indicator an
of whole economy activity attempt to bring together all the information contained in the European
are rare Commissions surveys of industrial, consumer, construction and retail
confidence into a monthly indicator of conditions on an economy wide basis;
The European Commissions indicator based forecasts of GDP forecasts for

the current quarter and quarter ahead GDP growth based on a selection of high
frequency indicators;
The USBW Monthly GDP model an attempt to build a bottom picture of all
the major expenditure components of GDP based on a combination of survey
and financial market data on a monthly basis.
Most high frequency data For some economies, data for the labour market can also be used to build up a
relates only to the industrial picture of activity across the whole economy. However, such data suffer from the
sector drawback that the labour market cycle typically lags the economic cycle by a couple
of quarters. Thus while useful for confirming an impression of accelerating or
decelerating growth, the labour market data are little help when it comes to
identifying turning points in activity. In addition, for the euro area at least, the data
on employment is still of fairly poor quality having both a short back history and
a long publication lag further limiting its usefulness.
53 UBS Warburg
Gross Domestic Product

Overview EU12 Gross Domestic Product
Frequency: Quarterly Market importance High
Normal publication date: 7 12
th th Market focus Real GDP
Normal publication lag: 10 weeks Key transformation % qoq / % yoy
Source: UBS Warburg
Description Gross Domestic Product (GDP) is the most comprehensive measure of economic
activity available and measures the sum of all goods and services produced within
the economy. The data are measured in nominal and constant price (real) terms and
are available on both a seasonally and non-seasonally adjusted basis. Constant price
data are re-valued to the average price level prevailing in a base year (currently
1995) to show the change in GDP once the effect of inflation has been removed.
This base year is updated every five years.
In principle there are three alternative ways of deriving estimates of GDP. The
expenditure approach aggregates total spending on finished (or final) goods and
services produced within the economy. The output (or production) approach sums
the output (or value-added) of each economic unit. The income approach
aggregates all the income earned by enterprises or individuals in the economy. As
of February 2002, Eurostat have published estimates of GDP based on all three
approaches. Prior to this date, estimates of GDP and its breakdown based on the
income approach were not available.
The initial estimates are published 70 days after the end of the quarter. A first
revision encompassing more detailed information is published after a further 30
days and a third and final estimate after a further 20 days (ie, 120 days after quarter-
end). Large-scale revisions to the headline growth rates between the initial and third
estimates of GDP are relatively rare, though the composition of growth can change
more significantly between the releases. The first and second releases give a
disaggregation of GDP by both category of expenditure and by category of output,
while a breakdown by income is not published until the third revision.
Table 11: Start date for quarterly

Over recent years, steps have been taken to harmonise the methodologies employed
GDP figures (ESA95 basis)
by national statistics agencies. Since April 1999, all euro area member states have
Euro area 1991 Q1 used the system known as the European System of Accounts (ESA95). Numerous
Germany 1991 Q1 changes to the way that activity was measured and classified were made as a result
France 1978 Q1 of this transition though many changes had offsetting impacts on the overall total,
Italy 1982 Q1 leaving GDP itself relatively unaffected. As is often the case in the euro area, full
Spain 1980 Q1 harmonisation has not occurred in a single step. For example, only Belgium,
Netherlands 1977 Q1 Germany, France, Spain and the Netherlands adjust the data for working days as
well as seasonal variations. However, the remaining major national idiosyncrasies
Source: UBS Warburg
should be removed by 1 January 2005.
54 UBS Warburg
The expenditure approach

The expenditure approach is the most commonly used approach to deriving GDP
and the most frequently adopted presentation used by policy makers and forecasters
to explain and analyse developments in the economy and their forecasts.
Chart 46: GDP expenditure shares The expenditure measure of GDP can be disaggregated into six principal sub-
components: private consumption (C), government consumption (G), investment
Data are for 2001 Net trade
2% (I), the change in inventories (S), exports (X) and imports (M).
Fixed investment GDP is defined by the following identity:

22%
Y = C + G + I + S + X M
Government
consumption 20%
Note that imports are deducted from the sum of the other components as they are
Private consumption
56% already included as part of consumption or investment, but they are not part of
domestic production. Note also that GDP includes all economic activity whether
Source: Datastream, UBS Warburg final sales or changes in inventory.
In addition to GDP and the six components, economists and policy makers also
commonly refer to three further aggregates; final domestic demand, domestic
demand and net trade. Final domestic demand is a measure of total spending by (or
sales to) domestic residents and governments but excludes changes in inventories. It
is calculated as C + G + I. Domestic demand adds in changes in inventories and
is a measure of spending by domestic residents and government excluding overseas
demand.
Net trade is simply the difference between exports and imports. However, as an
aside, it is worth noting that due to difficulties in recording the data, the trade
statistics in the national accounts include both intra and extra euro area trade. The
trade data therefore need to be interpreted carefully.
The output approach
Chart 47: Output shares of GDP

The output approach attempts to measure the output of all enterprises in the
economy. In order to avoid double counting, the output is measured as value-added
Data are for 2001 ie, the value of a firms output or sales, less the value of the raw materials or
Agriculture
3%
intermediate goods used in the production process. In addition to measuring value-
Public
Manufacturing added, the data are measured at basic prices, ie, including taxes or charges paid by
services 21%
23%
the producers (eg, operating licences) as well as any subsidies received, but
excluding taxes paid on products (excise duties or VAT) or subsidies.
Cons-
truction 5% The output measure of GDP can be split into six sectors:
Finance, real
Trade, tourism,
estate, business
communications 21%
Agriculture, hunting and fishing,
services 26%
Industry including energy,
Construction,
Trade, transport and communication services,
Financial and business activities, and
Other services.
55 UBS Warburg
The output for each sector is then weighted together according to its relative
importance in a base year (currently 1995). The base year and the industry weights
are reviewed and updated every five years. This aggregation gives a measure known
as gross value-added at basic prices, the headline figure of the output approach. To
derive a measure of GDP, rather than value-added, it is necessary to add on taxes
paid on products and subtract subsidies received, both of which are measured as
separate items.
The income approach

Chart 48: Income shares of GDP
The income approach to GDP measures the sum of employment income, profits (or
Data are for 2001
losses) of enterprises and taxes (net of subsidies) collected by general government.
In this approach, GDP is broken down into three components:
Taxes less
subsidies 12% Compensation
of employees
Compensation of employees total remuneration, in cash or kind and including
50%
social contributions paid to employees for work done.
Operating surplus and mixed income Operating surplus is the profit (or loss)
made by firms before accounting for interest, rents or charges associated with
Operating surplus/ the use of assets. Mixed income is a measure of work done by the owner (or
mixed income 38%
members of his family) of an unincorporated enterprise.
Source: Datastream, UBS Warburg Taxes less subsidies on production and imports measures compulsory
payments to general government or the European Union associated with the
production process.
Of these three components, compensation of employees is the largest component,

accounting for 50% of GDP at the euro area level. Operating surplus accounts for
38% of total GDP, with net taxes making up the remainder.
56 UBS Warburg
Chart 49: Domestic demand and net trade Chart 50: Breakdown of final domestic demand growth
5.0 5.0
% yoy % contribution to annual growth
4.0 4.0
3.0 3.0
2.0 2.0
1.0 1.0
0.0
0.0
-1.0
-1.0
-2.0
-2.0
Net exports Domestic demand GDP
Private consumption Government consumption Fixed investment
-3.0
-3.0
-4.0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Chart 51: Shares of GDP % Chart 52: Imports and exports as a share of real GDP
24.0 58.5 40
% of GDP % of GDP % of GDP
23.5 58.0 38
23.0 57.5 36
22.5 57.0 34
22.0 56.5 32
21.5 56.0 30
21.0 55.5 28
20.5 55.0 26
20.0 54.5 24
Imports of goods and services Exports of goods and services
19.5 54.0 22
Fixed investment (lhs) Government consumption (lhs) Private consumption (rhs)
19.0 53.5 20
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Chart 53: Industry versus services Chart 54: Public sector services slowly losing ground
7 140
% yoy 1991=100
6
135
5
4 130
3
125
2
1 120
0
-1 115
-2
110
-3
-4 105
-5
Industrial production Service sector output 100
-6 Trade, hotels , transport & communications Finance, real estate and business services
Public services
-7 95
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
57 UBS Warburg
Economic Sentiment Indicator
Overview Economic Sentiment Indicator

Published by: European Commission Series starts Jan 1985
Normal publication date: 1st week of month Market focus Headline index
Normal publication lag: 1 week Key transformation none
Coverage: EU12, Member States No. of components 4
Source: UBS Warburg
Description Unlike the other confidence indicators on which it is based, the European
Commissions Economic Sentiment Indicator is designed to reflect developments
across the whole economy rather than at the individual sector level. The indicator
Table 12: Summary statistics brings together the information contained in the four main confidence balances
EU12 Economic Sentiment Indicator derived from the monthly European Commission Business and Consumer survey.
Average level 99.7 No additional questions or information are used to derive the sentiment indicator.
Highest level 104.6
In recent years the European Commission has upped the profile of the sentiment
Lowest level 93.1
indicator relative to the components in published releases. However, markets still
Month-on-month changes
attach most weight to the industrial and consumer confidence balances.
Mean 0.3
Mode 0.0
The sentiment indicator is available for the euro area aggregate and all euro area
Biggest rise 1.2
member states back to 1985. It performs best as a coincident indicator of GDP
Biggest fall -1.4 growth and has a correlation co-efficient of 0.8 with annual real GDP growth. In
Source: UBS Warburg recent years, the indicators performance appears to have deteriorated.
Methodology The economic sentiment indicator is derived by weighting together month-on-

month changes of the four confidence balances produced by the European
Commissions monthly survey. The individual series are normalised to prevent
more volatile series dominating the indicator. Industrial confidence is given a
weight of 40%. Consumer, retail and construction confidence each has a 20%
weight. The current methodology dates from September 2001. The former
economic sentiment indicator used share prices in the place of retail confidence.
Chart 55: Economic sentiment indicator and GDP growth Chart 56: Economic sentiment indicator and IP growth
6.0 105 8 107

% yoy 1995=100 % yoy 1995=100
5.0 103 6 105
4.0 101 4 103
3.0 99 2 101
2.0 97 0 99
1.0 95 -2 97
Correlation = 0.80
Correlation coefficient = 0.75
0.0 93 -4 95
-1.0 91 -6 93
Industrial production (lhs)
Real GDP (lhs) Economic sentiment indic ator (rhs) Economic sentiment indic ator (rhs)
-2.0 89 -8 91
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
58 UBS Warburg
PMI Composite Indicator
Overview PMI Composite indicator

Published by: Reuters Series starts Jul 1998
Normal publication date: 3rd working day of month Market focus Index
Normal publication lag: 1 week Key transformation None
Coverage: Euro area No. of components 4
Source: UBS Warburg
Description In addition to the Manufacturing and Service sector surveys (see pages 70 and 75
respectively) the Reuters/PMI surveys incorporate a Composite indicator designed
Table 13: Summary statistics to give a better picture of developments across the whole economy. The composite
PMI composite indicator indictors cover some 74% of private sector activity in the euro area.
Average level 54.5
Highest level 62.6
The availability of the data is limited by the short history of the service sector
Lowest level 45.2
survey. Both the service sector survey and, as a result, the composite indicator
begin only in July 1998. The composite indicator is released along with the service
Month on month changes
sector figures, on the third business day of the month. But the composite series are
Mean 1.0
usually overshadowed by the service sector data.
Mode 0.7
Biggest rise 2.0
Although the composite indicator has a relatively low market profile, Chart 57
Biggest fall -2.9 shows that the output index has to date had a pretty good record of picking the
Source: UBS Warburg trends and turning points in aggregate GDP growth. The input price series also
tracks producer price inflation fairly reliably (Chart 58).
Methodology Reuters publish four composite indicators covering output, new orders, employment
and input prices. As with the service sector survey, the underlying data is not
aggregated into a single activity index as in the case of the manufacturing survey.
The composite series are calculated by aggregating the relevant manufacturing and
service sector diffusion indices using weights consistent with the shares of each
sector in the economy.
Chart 57: The composite output index has tracked GDP growth Chart 58: Input prices track PPI inflation
63 4.5 74 8
Diffusion index % yoy Diffusion index PMI composite input prices (lhs) EU12 PPI inflation (rhs) % yoy
61 4.0 71 7
68 6
59 3.5
65 5
57 3.0
62 4
55 2.5 59 3
53 2.0 56 2
53 1
51 1.5
50 0
49 1.0
47 -1
47 0.5 44 -2
PMI composite output index (lhs) EU12 GDP growth (rhs)
45 0.0 41 -3
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
1998 1999 2000 2001 2002 1998 1999 2000 2001 2002
Source: Reuters/ UBS Warburg Source: Reuters/ UBS Warburg
59 UBS Warburg
Indicator-based forecasts of euro area GDP
Overview Indicator-based forecast of quarterly GDP growth

Published by: European Commission Series starts 2002
Frequency: Every 3-5 weeks Market importance Low
Normal publication date: 1st /2nd Thurs of month Market focus % qoq
Normal publication lag: n/a Key transformation % qoq
Coverage: EU12 No. of components 6
Source: UBS Warburg
Description The indicator-based model of GDP is used by the Commission to derive forecasts of
quarter-on-quarter GDP growth for both the current quarter and the quarter ahead. It
is derived from a combination of high-frequency indicators of real economic
activity and financial variables.
The indicator was developed during 2001 the results have only been published
since the beginning of 2002. The models in-sample performance is good. The
mean absolute forecast error does not exceed 0.15%. The model successfully
predicts an acceleration/no change/deceleration in the q/q growth rates 75% of the
time for the co-incident quarter and 68% of the time for the quarter ahead.
However, the out-of-sample performance of the model has yet to be proven.
The models forecasts are presented in range form to reflect the uncertainty
surrounding such estimates. The error bands are symmetric, implying that the centre
of the range can be interpreted as the models point forecast for any given quarter.
The model gives estimates of quarter-on-quarter GDP growth but gives no clues as
to the drivers or composition of growth.
Methodology Two separate regression models are used to derive forecasts for the current and
following quarters. The indicators are: euro area car sales; the survey opinion on the
present business situation from the ECs retail confidence survey; the euro area
construction confidence indicator; the US ISM Manufacturing index, the relative
yield spread between euro area and US bonds; and the real effective euro exchange
rate. The variables were selected based on two criteria. Firstly, there had to be an
economic rationale for their inclusion. Secondly the variables were selected on their
ability to deliver useful results.
The co-incident model uses all six of the above variables, while the quarter ahead
model uses just five car sales being the variable not used. Both models have been
estimated between the second quarter of 1991 and Q4 00, the maximum period
allowed if only official euro area GDP data are used.
Table 14: Time line for the official statistics and indicator-based forecasts
QUARTER T
Month 1 Month 2 Month 3
Official data Q T-2 (2 release)
nd Q T-2 (3 release)
rd Q T-1 (1 release)
st
Co-incident model Q T-1 Q T-1 QT

Quarter ahead model QT QT Q T+1
Source: European Commission
60 UBS Warburg
UBS Warburg Monthly Euro GDP Model
Overview UBS Warburg Monthly Euro GDP Model

Published by: UBS Warburg Series starts Jan 1985
Frequency: Monthly Market importance n/a
Normal publication date: 1st week of month Market focus n/a
Normal publication lag: 1 month Key transformation None
Coverage: EU12 No. of components 13
Source: UBS Warburg
Description Official estimates of euro area GDP are available only 70 days after the end of the
quarter to which they refer. This delay is a problem for anyone involved in
forecasting and analysing the economy. And while there are a wide variety of high
frequency indicators available to economists, few of these map directly onto GDP
or its expenditure components, thus providing at best an approximation or partial
picture of growth across the whole economy. In addition, there is a high degree of
bias in the monthly data flow towards the industrial sector a sector that accounts
for less than a quarter of whole economy output.
UBSW have therefore developed a methodology that allows us to derive a picture

of developments across the whole euro area economy from the available monthly
activity data. Our monthly GDP estimate combines high frequency indicators to
develop a picture of each of the main expenditure components of GDP.
The model has been calculated back as far as 1993. The performance of the model
is far from perfect, but it does provide a reasonable guide to the trends in GDP
growth and its components. And unlike the European Commissions GDP indicator,
our model provides some indication of the source of growth.
Methodology In deriving our model we were looking for indicators that tracked the various
components of GDP, as well as variables with a short publication lag. We have
derived a model based almost exclusively on components of the European
Commissions surveys of industrial, consumer, construction and retail confidence.
Ten of our 13 input variables are taken from this source. The other three variables
are the EUR/USD exchange rate, three-month interest rates and German capital
goods orders. While it may be possible that other variables would improve our
ability to predict GDP growth moderately, our variable set allows us to derive
estimates of annual GDP growth some five to six weeks before the official statistics
are available.
In deriving our bottom up estimates, we have used simple regression analysis to estimate
models for each expenditure component of GDP. The co-efficients are reviewed on a
regular basis. The current models are estimated over the period Q1 93 to Q2 02 and the
inputs to each regression are listed in
Table 15 overleaf. The only component we do not attempt to model from a bottom-
up perspective is government spending where there is insufficient relevant high-
frequency data. To derive our GDP estimates, we use the figures from our top-down
forecasts.
61 UBS Warburg
Chart 59: Actual vs fitted Real euro area GDP growth Chart 60: Monthly GDP vs industrial production
5.0 8.0 5.0

% yoy GDP % yoy (3mma) % yoy (3mma)
4.0
6.0 4.0
3.0
4.0 3.0
2.0
2.0 2.0
1.0
0.0 1.0
0.0
-1.0
-2.0 0.0
Errors Actual Fitted Industrial production UBSW Monthly GDP

-2.0 -4.0 -1.0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1995 1996 1997 1998 1999 2000 2001 2002 2003
Source: UBS Warburg Source: UBS Warburg
Chart 61: Forecast errors for the regressions Chart 62: Other performance criteria high/ low/ directional
1.0 100
% Ppts Average absolute error in predicting year on year growth rates1 Per cent Correct predictions of accleration, deceleration or no change in annual growth rate
0.9
90
0.8
0.7 80
0.6
70
0.5
0.4 60
0.3
50
0.2
40
0.1
0.0 30
Consumption Investment Inventories Net trade GDP Consumption Investment Inventories Net trade GDP
Source: UBS Warburg Source: UBS Warburg
Table 15: The monthly GDP model regressions
Private Fixed
Sample period 1993Q1 to 2002Q2
consumption Investment Inventories Exports Imports
Constant 5.435 -1.194 98.611 0.326 -5.386
Economy - next 12m 0.077
Unemployment next 12m1 -0.026
Consumer prices last 12m -0.054
Retail stock levels -0.079
12mth change in 3m interest rates -1.039
Industry production expectations next 12m 0.166 0.398
Capacity utilisation rate -1.111
Stocks of finished goods industry -0.663
Consumer confidence -0.112
German manufacturing orders 0.273
Export expectations industry 0.178
Annual % change in trade weighted exchange rate -0.122 0.154
Present production capacity in industry 0.245
Lagged dependent variable 0.856 0.463 0.372 0.452
R-squared 0.96 0.90 0.76 0.95 0.97
Source: UBS Warburg; 1 unemployment expectations affect consumption with a twelve month lag, 2 this variable impacts stockbuilding with a three month lag
62 UBS Warburg
Euro Area Data Decoder March 2003 INDUSTRIAL PRODUCTION
Chapter 5: Industrial Production

Industry is a small part of Excluding construction, the industrial sector in the euro area accounts for a little
total economic activity under 23% of value-added and around 20% of total employment. Broadening the
definition of industry to include the construction sector adds a further 5% to the
share of value-added and a further 7% to employment.
But receives disproportionate The industrial sector accounts for approximately the same share of value-added as
attention public services and less than the finance, real estate & business services sector.
Despite this, it is readily apparent to anyone who follows the flow of economic
analysis and commentary that the industrial sector receives a highly
disproportionate amount of commentary, survey and analytical effort.
thanks to the relative glut One of the reasons for this is simply expediency. Unlike the service sector or
of available data consumer spending, comprehensive high-frequency data of reasonable quality is
widely available for the industrial sector. Although there is no hard data on orders
on a euro area wide basis, information on orders as well as on capacity utilisation,
and employment intentions is available from the many timely surveys of industrial
activity. It is therefore natural that economists and commentators give priority to the
known rather than the unknown. Surveys of the service sector, while they do exist
(see pages 75 and 76), are relatively new and unproven and do not typically provide
the same depth of information.
...and its more cyclical nature Another reason however, is that activity in industry tends to be more cyclical than
the service sector and responds more rapidly to changes in the external global
environment as well as to changes in fiscal and monetary policy. As Chart 65
shows, industrial production accounts for most of the cyclicality of GDP growth
while turning points in the industrial cycle almost always coincide with turning
points in GDP growth. It is therefore a natural starting point when attempting to
analyse how and over what time period the economy might react to changes in
macro-economic policy or shifts in the external environment.
Chart 63: Industry one-fifth of GDP and employment Chart 64: Construction 5% of output and 7% of employment
27 8.5
Per cent of total Per cent of total
8.0
26
Value added Employment 7.5
25
7.0
24 6.5
Value added Employment
23 6.0
5.5
22
5.0
21
4.5
20 4.0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
63 UBS Warburg
Chart 65: Industrial production drives the cyclicality of GDP Chart 66: Contribution to average manufacturing growth
7 0.6 3.5
% yoy Contribution to manufacturing growth (1996 to date)
6
0.5 3.0
5 Cumulative
actual per sector
4 0.4 2.5
3
0.3 2.0
2
1
0.2 1.5
0
-1 0.1 1.0
-2
0.0 0.5
-3
-4 -0.1 0.0
-5
min t
r
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ts
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Industrial production Service sector output Real GDP
ile
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sh
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od
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1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Ra
ec
Ot
El
Euro area industry remains In terms of the structure of euro area industry, Chart 67 shows that there are a few
dominated by a few large large sectors that dominate. Taken together the food & beverages, chemicals and
sectors machinery & equipment sectors account for almost a third of production, and the
top six industries account for half of all production. The high tech sectors, defined
as radio, TV & communications and office machinery account for under 4% of the
index. But as Chart 66 shows the communications sector has been the fourth largest
contributor to manufacturing growth over the past seven years despite the rapid
slowdown seen since Q2 00.
Chart 67: The structure of euro area industry
11
% of total industry
10
0
eq als
No l and ter
als
eta co
es
an nstru s
tor cts
Ele g & es
ici ent
re
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ly
ts
s e hing
pro y
llic ery
lp cs
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Ba rals
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e m um
pe
dp n
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le
eta nite
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Me supp
ore
o
ort men
itu
ine
rag
ac
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Mo odu
hic
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me
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cti
pa
m
nti
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eta hin
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s
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t
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lig
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pla
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Te
Of etrol
Le ach
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llic
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he
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n-m mac
xtr
mi
pr
r
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ty
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un
&
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eq
tal
er
Pu
er
oo
mm
ctr
&
fm
&
i
l
ath
in
ica
ga
ao
ine
al
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ry
sh
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fc
sp
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nd
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ine
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bli
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la
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Pu
io,
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r tr
Oi
nin
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Mi
Ma
he
Mi
,R
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TV
Source: Eurostat
64 UBS Warburg
Industrial production
Overview EU12 Industrial confidence

Normal publication date: 18th to 21st Market focus Ind prodn excl constrn
Normal publication lag: 7-8 weeks Units Index 1995=100
Source: UBS Warburg
Description
The index of production measures the month-by-month changes in the volume of
gross value-added generated by industry. In terms of the headline euro area figures,
industry is defined so as to exclude the value-added of the construction sector. This
is in line with the convention in most of the major states, the exception being
Germany where the headline industrial figures are reported including construction.
Although separate figures for construction value-added and for industry including
construction are also calculated by Eurostat, these are only available around a
month after the ex-construction figures.
The headline production figures can be split in to five main industrial groupings.
These are energy (12.1%), intermediate goods (36.1%), capital goods (25.2%),
durable consumer goods (4.4%) and non-durable consumer goods (22.2%). The
weights for each sector (given in brackets above) are derived from a detailed survey
of industrial value-added in 1995. This five-category breakdown is routinely
published in Eurostats regular monthly press release although it is also possible to
obtain a more detailed breakdown. The manufacture of office machinery and
computers and of telecoms equipment is classified under capital goods.
Methodology The Eurostat index of production is derived from raw data provided by national
statistics authorities. The data is transmitted having been adjusted for variations in
the number of working days and in some cases, seasonally adjusted data is also
provided by the member states. Eurostat make its own seasonal adjustments for the
remainder.
Table 16: Country weights
By convention, month-on-month changes in production are based on a seasonally
Germany 37.1 adjusted index while annual changes are based on a working day adjusted index.
France 18.9
Italy 18.4 The aggregate working day adjusted euro area series are derived as the weighted
Spain 7.8 arithmetic averages of the national series. The country weights are set out in Table
Netherlands 4.8 16. Eurostat then apply a seasonal adjustment to this index rather than aggregate the
Belgium 4.0 national seasonally adjusted indices.
Austria 3.3
Finland 2.0 Although industrial production data for the euro area exist on a monthly basis back
Portugal 1.6
to January 1985, the data are compiled treating the euro area as an entity regardless
of its composition. In other words, the data relate to the EU12 from January 2001
Ireland 1.5
and the EU11 prior to that. However, Eurostat have created a consistent series for
Greece 0.7
the EU12 back to January 1990
Luxembourg 0.2
Source: UBS Warburg
65 UBS Warburg
Industrial confidence
Overview EU12 Industrial production

Normal publication date: 1st week of month Market focus Industrial confidence
Normal publication lag: 1 week Units % balance
Coverage: EU12
Source: UBS Warburg
Description
The European Commissions industrial confidence indicator is the only truly euro
area wide measure of sentiment in the industrial sector. As with the other surveys
conducted by the Commission, the indicator is not a direct measure of industrial
activity, but rather a measure of sentiment. The industrial confidence indicator has a
weight of 40% in the European Commissions Economic Sentiment Indicator. The
underlying data also forms the basis of the European Commissions Business
Climate Indicator.
The survey is made up of 13 questions, which are reproduced in Table 18, covering
everything from production trends (both recent and expected), orders (both the
stock and flow), stock levels, expected selling prices, employment intentions as
well as issues of capacity. However, data is collected monthly for only seven of the
13 questions, the remainder being collected only in the first month of each quarter.
The focus of the industrial survey is typically the headline industrial confidence
indicator, which has a correlation of 90% with annual industrial production growth.
Although the confidence indicator is a coincident, rather than a lead indicator, the
results for any given month are available six to seven weeks before the official
production data. These two factors make it a key indicator for short-term analysis.
Methodology The survey originated in 1962 and was conducted in each of the six member states
of the Community. It is now conducted in all 12 euro area member states and is
generally available on a monthly basis back to January 1985. Data for Spain and
Portugal are available only from 1987 and from 1993 in the case of Finland.
Table 17: Summary statistics
The industrial confidence indicator is constructed from the responses of a monthly
EU12 Industrial confidence telephone survey (conducted by national statistics or polling organisations on the
Average level -7 Commissions behalf) Some 50,000 companies are surveyed. The survey is
Highest level +8 conducted between the first and 10th day of each month.
Lowest level -31
Month-on-month changes The industrial confidence indicator is calculated as the arithmetic average of the
Mean (absolute) 1.2 responses on production expectations, order book assessments and stocks (the latter
Mode (absolute) 1.0 with an inverted sign).
Biggest rise +3.0
Biggest fall -5.0
The responses are presented in % balances (the difference between respondents
giving positive and negative answers labelled P and N in Table 18). Neutral or
Source: UBS Warburg
dont know answers (=) are discarded. National results are aggregated using the
share of national value-added in euro area industry as weights.
66 UBS Warburg
Table 18: European Commission industrial confidence survey: the questionnaire

Q1 Production trends in recent past Q7 Employment expectations for the month ahead
P Up P Up
= Unchanged = Unchanged
N Down N Down
Q2 Order books Q8 Limits to production
P Above normal None

= Normal Insufficient demand
N Below normal Shortage of labour
Lack of equipment
Other
Q3 Export order books Q9 Production capacity
P Above normal P More than sufficient

= Normal = Sufficient
N Below normal N Not sufficient
Q4 Stocks of finished products Q10 New orders in recent past
P Above normal P Up
= Normal = Unchanged
N Below normal N Down
Q5 Production expectations for the month ahead Q11 Export expectations for the months ahead
P Up P Up
= Unchanged = Unchanged
N Down N Down
Q6 Selling price expectations for the month ahead Q12 Duration of assured production: in months?
P Up Q13 Capacity Utilisation: in %

= Unchanged
N Down
Chart 68: Industrial confidence and the business climate Chart 69: Correlation with industrial production growth
10 2 1.0
% balance Std dev'ns Correlations with industrial production growth (% yoy)
5 1.5
0.9
0 1 Industrial confidence
0.5 0.8 Business climate
-5
0
-10 0.7
-0.5
-15
-1 0.6
-20
-1.5
0.5
-25
-2
Industrial confidence (lhs) Business climate index (rhs)
-30 -2.5 0.4
0m 1m 2m 3m 4m 5m 6m
-35 -3
Industrial confidence/business climate led by X months
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003
Source: Datastream, UBS Warburg Source: UBS Warburg
67 UBS Warburg
Business climate indicator
Overview EU12 Business climate indicator

Frequency: Monthly Market importance Medium
Normal publication date: 1st week of month Market focus BCI
Normal publication lag: 1 week Units Points of std devn
Coverage: EU12
Source: UBS Warburg
Description The business climate indicator (BCI) is a variant of the industrial confidence
indicator and is compiled from the same basic raw data. However, the premise
behind the BCI is that each response in the industrial survey can be broken down
into two parts. The first, or the common component, is conditioned on the
underlying state of the business cycle at that point in time while the second, specific
component, is directly related to the question being asked.
The objective of the BCI is to separate out these two components and derive an
indicator based purely on the common cyclical factor. In doing this, the BCI should
help to diminish the impact of conflicting signals occasionally sent by the
components of the industrial survey, eg, when production expectations are rising
but order book assessments are falling. But while the BCI and confidence balances
may diverge slightly in the short term, Chart 68 shows that the underlying trends of
the two series are closely related. The BCI has a slightly higher correlation with
industrial production but offers no more in terms of lead indicator properties than
the industrial confidence balance (Chart 69).
The BCI is a relatively new indicator, first introduced towards the end of 2000. It is
published in the first week of the month the day following the release of the
industrial survey results. However, as the indicator is derived from the underlying
industrial survey data, a back history has been made available as far as January
1985. Unlike the confidence balance however, the climate indicator is only
calculated for the euro area as a whole. It is not available at the member state level.
Methodology The BCI is derived using the information in five of the seven monthly questions set
out in Table 18. Only question 6 on selling prices and question 7 on employment
are not used. In addition, the Commission use only responses aggregated to the euro
area level an assumption that views the euro area economy as a single entity
rather than a collection of independent economies. While such an assumption is
EU12 Business climate indicator likely to be increasingly appropriate going forward, it may be less apt over the past.
Average level 0.0
Highest level +1.8 The statistical technique used to separate the common and specific components of
Lowest level -2.6 the survey responses is known as factor analysis and is based on regression
Month-on-month changes techniques. Although the specific and common factors can be separately
Mean (absolute) 0.14 identified for each survey component, these details are not routinely published.
Mode (absolute) 0.01
Biggest rise +0.6
The data are presented in standard deviation terms with 0 representing a cyclically
neutral position. A positive number represents a favourable cyclical position and a
Biggest fall -0.6
negative reading signals a depressed cyclical position.
Source: UBS Warburg
68 UBS Warburg
Chart 70: Manufacturing fastest growing sectors Chart 71: Manufacturing slowest growing sectors
180 110
Jan 1995 =100 Relative performance Jan 1995 =100 Relative performance
170
Radio, TV & Communic ations 100
160 Office machinery & computers
Motor Vehicles
150 90
Chemicals
Medical instruments
140
80
130
120 70
Tobacco Clothing
110
60 Textiles Wood
100
Furniture
90 50
1995 1996 1997 1998 1999 2000 2001 2002 1995 1996 1997 1998 1999 2000 2001 2002
Chart 72: PMI tends to signal turning points first... Chart 73:...but all main surveys have high correlation with IP
3.0 0.94
Normalised standard deviations EC Industrial confidence PMI Correlation with EU12 Industrial Production growth
Ifo survey EC Business Climate Indicator 0.92

2.0
0.90
1.0 0.88
0.86
0.0
0.84
-1.0 0.82
0.80
-2.0
0.78
-3.0 0.76
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Business Climate Industrial confidence PMI ( 2 month lead) IFO
Source: Datastream, UBS Warburg Source: Datastream, Reuters, UBS Warburg
Chart 74: Components of industrial confidence Chart 75: PMI tends to anticipate industrial production growth
30 0.95
% balance Correlation with Industrial Production growth
20
0.90
10
0.85
0
0.80
-10
-20 0.75
-30 0.70
-40
0.65
-50
0.60
Production expectations Stocks above normal Order books satisfactory
-60 t=0 t-1 t-2 t-3 t-4 t-5 t-6
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 PMI led by X months
69 UBS Warburg
Purchasing Managers Index Manufacturing
Overview Euro area PMI Manufacturing

Published by: Reuters Series starts Jun 1997
Normal publication date: 1st working day of month Market focus Headline index
Normal publication lag: 1 week Units Diffusion index
Coverage: Euro area
Source: UBS Warburg
Description The Purchasing Managers Index PMI is an important indicator of conditions in the
euro area manufacturing sector. It is derived from the responses to a monthly survey
Table 20: Summary statistics of 2,500 manufacturing companies based in eight member states. The states that are
Euro area PMI (Manufacturing)
not represented within the survey are Belgium, Finland, Portugal and Luxembourg.
The countries that are included thus represent approximately 92% of euro area
Average level 52.6
industrial production. The survey is conducted in the second half of the month and
Highest level 60.5
the results are published on the first business day of the following month.
Lowest level 42.9
Month-on-month changes The survey has a limited history back to June 1997. However, the surveys track
Mean 1.0 record is good. Its correlation with annual euro area industrial production growth
Mode 1.0 over this period is highest - at 90% - when given a two-month lead. Thanks to this,
Biggest rise 2.3 the indicator has typically signalled turning points in the industrial cycle two to
Biggest fall -3.0 three months ahead of the European Commissions more established industrial
confidence data.
Source: UBS Warburg
Methodology The methodology of the PMI is based on the US ISM (formerly NAPM) survey.
The headline PMI index is a composite index based on the response to five
questions. Companies are asked about their level of new orders, output,
employment and stocks of purchased items compared with the previous month.
There are three possible responses: higher, the same and lower. In addition,
companies are asked whether the delivery times of their suppliers have got `faster,
stayed `the same or got `slower than a month ago. There is also a sixth question on
developments in input prices but this does not feed into the headline index.
Table 21: Deriving the PMI index The response `higher is awarded one point, `the same 0.5 points and `lower 0
points. The responses to each question are then transformed into an index centred
PMI Headline components Weights around 50. In other words, if all (100%) respondents had replied `the same, the
New orders 0.30 index would be 50. A reading above 50 indicates expansion, a reading below 50
Output 0.25 contraction. This methodology differs from the more usual percentage balance
Employment 0.20 presentation where `dont know responses are discarded. The indices for the five
Delivery times 0.15
responses are then aggregated into the single headline activity index. The weights
used for this aggregation are set out in Table 21. Note that the responses regarding
Stocks of purchases 0.10
delivery times are inverted as longer delivery times are seen as a sign of bottlenecks
Source: Reuters and higher rates of activity.
The inclusion of the `dont know/the same responses in the PMI may be one reason
why the survey tends to detect turning points earlier than other surveys. It seems
reasonable to assume that in times of uncertainty, responses are likely to cluster in
the `dont know/ the same category a subtle shift that may not be picked up by
the traditional % balance surveys.
70 UBS Warburg
Ifo Business Climate Index

Overview Ifo Business Climate Index
Published by: Ifo Institute Series starts 1960
Normal publication date: 3rd week of month Market focus Headline confidence index
Normal publication lag: none Units Index (1991=100), % bal.
Coverage: West, East Germany
Source: UBS Warburg
Description There are two reasons why it might appear odd to discuss the ifo survey here.
Firstly, it is not a euro area indicator, but a German one (in fact, financial markets
focus exclusively on the west German part); and secondly, it is not a pure industry
indicator, but covers the construction, retail and wholesale sectors as well.
Nevertheless, we feel that no guide to the euro area would be complete without it.
For as well as being a reliable guide to activity in the German economy, the ifo
survey has also been an indispensable indicator of euro area growth in the past.
Methodology The ifo survey is based on the responses to a monthly survey in which more than
7,000 firms participate. The closely watched headline business climate index is
based on only two constituents, firms perceptions of current business conditions
(good, satisfactory, bad) and expectations for the coming six-months (rather
improve, remain unchanged, rather less favourable). Responses are transformed into
seasonally adjusted percent balances whose scale ranges from 100 (all non-neutral
responses negative to +100 (all non-neutral responses positive). The balance is zero
when positive and negative responses are in balance. For publication purposes, ifo
translates the balance into an index (normed 1991=100). Using the index, however,
one loses the information whether pessimists or optimists dominated in the survey.
We therefore prefer the balance measure.
The ifo business confidence indicator has several advantages that more than
outweigh the fact that it is a geographically narrow measure. It has, by European
standards, an extraordinarily long history (data is available back to 1960) and a
broad statistical base, including not only larger, but also smaller firms.
Chart 76: 43 years of ifo history Chart 77: Cyclical pattern of the ifo components
60 30
Index, 1995=100 Recovery Boom
40 20
Expectations, next six month
Jan 00
10
20 Jan 98
0
0 Jan 01
-10 Jan 99
Jan
-20 02
-20
-40 Recession Slowdown
-30
Headline index Current conditions Expectations -35 -30 -25 -20 -15 -10 -5 0 5 10 15 20 25 30
-60
Current business conditions
60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02
Source: Datastream, UBS Warburg Source: Ifo business cycle pattern
71 UBS Warburg
The detailed breakdown of the survey allows for conclusions regarding different
sectors. Questionnaires are filled out for each individual good produced by the
participating firms. In other words, larger companies with a broad range of
produced goods will contribute different questionnaires for each department. The
weighted (by company size) results are then combined for industry sectors.
The information provided by the survey goes well beyond the headline index and its
two constituents. The questionnaire overleaf illustrates that data on companies
assessment of inventories, orders, export orders, selling prices and employment are
available. For most of these categories, backward looking as well as forward-
looking indicators are included.
Interpretation As far as the interpretation of the main sub-indices of the ifo survey are concerned,
Chart 77 illustrates how different combinations of current conditions and business
expectations can be associated with the four stages of a business cycle.
Improvements in the expectations component are usually an early signal for
economic recovery, even if current conditions are still at recessionary levels. We
Table 22: Summary statistics* usually speak of recovery if both current conditions and expectations rise. At the
peak of the business cycle (boom phase), expectations are beginning to reverse
Headline ifo balance
while current conditions may well improve. It is interesting to note that the four
Average level -3.9
phases of a business cycle have no symmetrical representation in the ifo survey
Highest level 31.4
apparently, there is a pessimistic bias in the responses.
Lowest level -44.8
Biggest monthly rise 9.7 Chart 78 illustrates how well the ifo data works as a leading indicator not only for
Biggest monthly fall 8.7 German, but for euro area GDP growth. The line labelled ifo model represents a
Current conditions balance simple regression of the ifo data on annual euro area GDP growth. Owing to their
Average level -4.5 timely publication, the monthly data allow for relatively early assessment of the
Highest level 45.7 quarterly GDP data (approximately three months before the official GDP release by
Lowest level -56.6 Eurostat).
Expectations balance
Average level -3.0
We use the ifo not only for GDP projections. Especially the expectations component
is a good guide to future capex growth. Derivatives of the survey data even provide
Highest level 23.8
interesting leading directional indicators for industrial production growth: the
Lowest level -43.4
difference between the expectations and current conditions components of the ifo
Source: UBS Warburg; *West German ifo, has a significant lead over euro area output data, as Chart 79 suggests (see section
balances
on leading indicators below). The difference between the assessment of inventories
and orders in the manufacturing part of the survey also has a relatively good, albeit
less convincing correlation with output growth. Beyond this, as is highlighted in the
section on page 113, the ifo survey also makes a valuable contribution to our euro
area Turning Point Indicator.
It has repeatedly been the case that ifo releases have had an impact on interest rate
expectations, if not ECB decisions. Owing to the absence of a publication lag (the
reporting period for the survey is identical with the publication month), they appear
to be superior to the European Commission surveys, despite its limited geographical
coverage.
72 UBS Warburg
Table 23: German ifo confidence survey: the questions (manufacturing, product XY)
Current situation Expectations for the next 3 months Special questions

Q1* We consider our current business situation for XY Q8 Our domestic output of XY will probably A1) We currently work overtime
good increase yes no
satisfactory remain unchanged A2) If so, more than usual
bad decline yes no
Q2 Our inventory of unsold finished goods in XY Q9 Our domestic selling prices (net) for XY will likely B1) We operate short shift
too low increase yes no
satisfactory (normal) remain unchanged B2) We will work short shift in the next 3
too high decline months
normally no inventory Q10 The volume of our export business will probably yes no
Q3 We consider our stock of orders for XY increase C) Considering the expected sales
total export remain unchanged development in the next 12 months,
relatively large decline we consider our employment
satisfactory Q11 Employed: The number of domestic employed - too high (reduction needed)
too small involved in the production of XY will - appropriate
we do not export XY increase - too low (more staff needed)
Tendencies in the last month remain about unchanged
Q4 The demand situation for XY has decline
improved Expectations for the next 6 months
worsened Q12* In cyclical terms, our business situation for XY will
remained unchanged rather improve
Q5 Our stock of new orders (domestic, foreign, value) has remain about unchanged
increased rather deteriorate
remained unchanged
declined
Q6 Our domestic output (adj. for seas. and cal. swings) has
increased
remained unchanged
declined
no notable domestic prod.
Q7 Our domestic selling prices (net) for XY have been
increased
left unchanged
lowered
Source: Ifo; *Constituent of headline business confidence
Chart 78: Using ifo as a leading euro area growth indicator Chart 79: A leading indicator for euro area production
5.0 8
% yoy % latest 3m on Index points 30
Euro area GDP growth a year earlier
4.0 6 25
4 20
3.0
2 15
2.0
0 10
ifo model*
1.0
-2 5
0.0
-4 0
-1.0 -6 -5
IP excl constr'n (lhs) IFO Future minus current conditions(rhs)

-2.0 -8 -10
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Source: UBS Warburg; *simple regression of German ifo against annual euro area Source: Datastream, UBS Warburg
GDP growth
73 UBS Warburg
Euro Area Data Decoder March 2003 SERVICES
Chapter 6: Services
High frequency data on the Considering that the service sector accounts for between 65 and 70 per cent of most
service sector is extremely euro area economies, there is precious little information about how the sector is
limited performing on a month-by-month, or even quarter-by-quarter basis. Recently,
however, two new monthly surveys, the Reuters services index (also sometimes
called the Services PMI), and the European Commissions Services confidence
indicator, have been added to the available data set.
Two new monthly surveys These two surveys are outlined in more detail in the following pages, but it is
have been introduced in probably fair to characterise them as having medium to low importance in financial
recent years market terms. One reason for this may be their relatively limited track record. For
example, the service sector survey produced by the European commission dates
back only as far as April 1995, while the Reuters services index is an even more
recent addition, beginning in July 1998. Alternatively, it may be that, although the
service sector dominates industry in terms of both value-added and employment,
turning points in the economic cycle are more typically signalled by the more
cyclically responsive industrial sector (see for example Chart 65).
...and capture the main Chart 80 and Chart 81 show how the surveys track the annual growth of service
trends the service sector sector value-added at the euro area level. Although the surveys clearly capture the
output growth main trends in service sector growth, the charts suggest that their track record is too
short to make them reliable indicators of service sector value-added growth on a
quarter-on-quarter basis. In particular, both surveys failed to signal the surge in
service sector activity in Q4 01. For the record, the EC service sector survey has a
correlation coefficient of 0.46 with annual service sector value-added growth, while
the Reuters services index has a correlation coefficient of just 0.36.
Both surveys are simple aggregates of the total private services sector and offer no
detailed breakdown of activity or sentiment in the various sub-sectors. However,
despite this and their limited correlation with national accounts service sector data,
due in the main to their limited history, both surveys are worth keeping an eye on if
only on the principle that any information is better than none.
Chart 80: EC Services survey and service sector value-added Chart 81: Reuters PMI services index and services value-added
40 5.0 63 5.0
% balance % yoy % balance % yoy
35 4.5 61 4.5
30 4.0 59 4.0
25 3.5 57 3.5
20 3.0 55 3.0
15 2.5 53 2.5
10 2.0 51 2.0
5 1.5 49 1.5
0 1.0 47 1.0
-5 0.5 45 0.5
EC Service sector survey (lhs) Service sector value added (rhs) Reuters PMI service sector survey (lhs) Service sector value added (rhs)
-10 0.0 43 0.0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
74 UBS Warburg
Reuters Services Index
Overview Reuters Services Index

Published by: Reuters Series starts July 1998
Normal publication date: 3rd working day Market focus Business activity
Normal publication lag: 1 week Units Diffusion index
Coverage: Euro area
Source: UBS Warburg
Description The Reuters Services Index also sometimes known as the Services PMI is a
monthly survey of developments and sentiment in the private services sector. The
euro area index is derived from data collected from regular monthly surveys
undertaken in five economies Germany, France, Italy, Spain and Ireland. These
five economies together account for more than 80 of the aggregate EU12 service
sector. In total, more than 2000 companies are surveyed on a monthly basis to
provide the data for the series.
The survey has a limited history it exists back only as far as July 1998. Although
we would not describe the series as a key statistic in terms of market moving
potential, its profile is steadily rising and it has a higher profile than the main
alternative services survey that produced by the European Commission and
discussed on the following page.
Methodology The survey asks companies about the evolution of six aspects of their business
using the previous month as the basis for comparisons. Three responses are
permitted Ùp, `Down and Ùnchanged. The six questions cover; overall
business activity, new business, outstanding business, employment levels, as well
both input and selling prices. In addition, the companies are asked about their
expectations for overall business activity in 12 months time.

With the exception of the forward-looking activity question, all the responses are
Reuters Services index Index seasonally adjusted. All seven indices are presented as diffusion indices, which are
Average level 55.3 calculated as follows. The response Ùp is awarded one point, Ùnchanged 0.5
Highest level 62.4 points and `Down 0 points. The responses to each question are then transformed
Lowest level 46.7 into an index centred around 50. In other words, if all (100%) respondents had
Month-on-month changes Index pts
replied `the same, the index would be 50. A reading above 50 indicates expansion,
a reading below 50 contraction. This methodology differs from the more usual
Mean (absolute change) 1.0
percentage balance presentation where `dont know responses are discarded.
Mode (absolute change) 0.6
Biggest rise 2.9
The backward looking `business activity series is regarded as the headline Services
Largest fall -2.6
Index. It is worth noting that unlike the manufacturing PMI, or indeed most surveys
Source: UBS Warburg of business confidence, the Reuters Services index is not a composite series, but the
answer to a single question.
75 UBS Warburg
EC Service Sector Survey
Overview European Commission Service Sector Survey

Published by: European Commission Series starts April 1995
Normal publication date: 1st working day Market focus Headline index
Coverage: Euro area, Member States
Source: UBS Warburg
Description The European Commission Service Sector Survey is a relatively recent addition to
the programme of Business and Consumer surveys, which encompasses the
business, consumer, construction and retail confidence series discussed earlier in
this document. The service sector survey was introduced in recognition of the
increasingly important role of services in the euro area economy. At the euro area
level, the series is available back to April 1995. In view of its relatively recent
history, the series does not feature in the composite Economic Sentiment Indicator.
The service sector survey receives relatively little attention in financial markets.
This may be partly because it is released at the same time as the much higher profile
industrial and consumer confidence series, and partly because of its limited history
and track record.
Methodology The survey comprises five questions covering recent and expected future
developments surrounding demand and employment as well as a more general
Table 25: Summary statistics assessment of the current business climate. The questionnaire used to conduct the
survey is reproduced in Table 26 below.
EC Service sector survey % bal
Average level 21.6
The responses to all the questions are presented as % balances (the difference
Highest level 34 between the number of respondents giving a positive and a negative response).
Lowest level -6 Neutral, or dont know answers are discarded. Euro area aggregates are derived
Month-on-month changes % pts from weighting together the national series. The weights reflect the share of each
Mean (absolute change) 1.6 Member State in aggregate gross value-added of the private service sector.
Mode (absolute change) 0.0
Biggest rise 7 The headline service sector series is derived as a weighted-average of the responses
Largest fall -14 to questions concerning the recent and expected evolution of demand (Q2 and Q3)
as well as the question addressing the assessment of the current business climate
Source: UBS Warburg
(Q1).
Table 26: Service Sector Survey - Questionnaire
satisfactory
Q1. Assessment of the business climate Good bad
(normal for the season)
Q2. Evolution of demand in recent months Up unchanged down
Q3. Evolution of demand expected in the months ahead Up unchanged down
Q4. Evolution of employment in recent months Up unchanged down
Q5. Evolution of employment expected in the months ahead Up unchanged down
76 UBS Warburg
Euro Area Data Decoder March 2003 INVESTMENT
Chapter 7: Investment
Investment is the second Investment, or gross fixed capital formation as it is known in the National
largest component of GDP Accounts, is the second largest component of domestic demand and accounts for
around 20-25% of GDP. Over the past decade, investment has, on average, added
around 0.5 percentage points to annual GDP growth each quarter.
Details of the composition of Investment covers a wide range of activities including construction of residential
investment are hard to obtain property, commercial office blocks and roads, the acquisition of capital machinery
on a timely EU12 basis as well as acquisition of IT hardware and intellectual property rights. Despite the
broad range of activities captured by the aggregate investment series, official
national accounts press releases do not include any disaggregation of the investment
data. Eurostat do calculate a breakdown of investment by product but the data is
available only with a considerable lag and is not widely disseminated.
though data from the EU4 But by using national data, it is possible to construct a separate series for
is available construction and machinery and equipment investment from the breakdowns
provided by each of the four largest euro area economies. Chart 89 shows that
annual growth of a total investment series derived on an EU4 basis, tracks the
official EU12 data closely, which suggests that proxying the components in this
way should not give misleading signals. The data show that, at present, construction
accounts for around 50% of total EU12 investment, but if Germany is excluded, this
falls to 45%.
Even this limited breakdown of investment can be helpful, however, because as

Chart 86 and Chart 87 show, the two series do not always move in synch, with
equipment investment being much more sensitive to the economic cycle than the
construction component. This is due in part to the fact that governments are often
tempted to use construction projects as a means of supporting the sector in times of
economic downturns.
High frequency indicators are When it comes to high frequency indicators of investment activity, there is little in
few and far between the way of genuine euro area wide data. For example, there is no euro area data on
capital goods or construction orders, nor is there data on housing sales, housing
starts/completions or even building permits issued.
Chart 82: Construction investment and output closely linked Chart 83: Equipment investment and capital goods production
8 15 25.0
% yoy % yoy
6 20.0
10
4 15.0
2 10.0
5
0 5.0
-2 0 0.0
-4 -5.0
-5
-6 -10.0
-8 -15.0
-10
Machinery and equipment investment EU12 Capital goods production
-10 -20.0
Construction investment Construction output German capital goods orders
-12 -15 -25.0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
77 UBS Warburg
Chart 84: Euro area investment share of GDP Chart 85: Investment contribution to GDP growth
23.0 5.0
% yoy
22.5 4.0
3.0
22.0
Value Volume 2.0
21.5
1.0
21.0
0.0
20.5
-1.0
20.0 -2.0
Contribution from fixed investment Real GDP growth
19.5 -3.0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Chart 86: Construction and equipment investment not in synch Chart 87: Construction less cyclical than equipment investment
8 15
% yoy % yoy y = 4.53x - 6.14
2
6 R = 0.81
10
4
5
2
y = 1.15x - 1.70
2
Investment
R = 0.33
0 0
-2
-5
-4
-6 -10
Construction Machinery and investment
-8 % yoy
-15
Construction Machinery and equipment Total
-10 -2 -1 0 1 2 3 4 5
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 ReaL GDP growth
Chart 88: Over capacity in German construction still an issue Chart 89: The EU4 is a good proxy for the EU12
70 10 16
% of total Construction as a share of total investment % yoy % qoq
8 14
EU12 EU4
65
6 12
4 10
60
2 8
55 0 6
-2 4
50
-4 2
-6 0
45
-8 -2
EU3 (France, Italy, Spain) Germany
40 -10 -4
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
78 UBS Warburg
The industrial production

The best source of high frequency data on investment comes from the construction
report provides some
and capital goods output series, which are published as part of the monthly
industrial production report (Chart 82 and Chart 83). Construction output in
information...
particular shows a close relationship with the corresponding proportion of
investment. The major drawback is that construction output data is only available
some 12 weeks after the end of the reference period five weeks behind the main
industrial production release.
Meanwhile data on capital goods output available since 1995 clearly has
captured the main trends in equipment investment but seriously overstated the
weakness seen in 1999. The chart also shows that, despite their narrow coverage,
German capital goods order can be a useful supplement to the euro area data on
capital goods production, acting as something of a lead indicator.
...while the ECs construction The other main euro area data source with relevance to the investment outlook is
survey... the construction confidence survey conducted on a monthly basis by the European
Commission. While it is a measure of companies expectations and assessment of
conditions in the sector, rather than a measure of real activity, it nevertheless gives
an impression of developments in the construction sector three months earlier than
the official output data. However, as Chart 92 shows, the relationship between
reported construction activity in the survey and actual construction investment is
loose.
...and industrial confidence The final piece of data not so far mentioned is the quarterly survey of industrial
survey also give a useful capacity utilisation gathered as part of the ECs industrial confidence survey. The
steer data is simply companies assessment of how close to full capacity they are
operating. As a rule, the quarter-on-quarter change in investment tends to follow the
quarter-on-quarter change in capacity utilisation, though again this relationship is
far from infallible.
Given the difficulty of building a bottom up picture of euro area investment from
high frequency sources, it is worth remembering that the aggregate investment and
industrial cycles are highly correlated in the euro area. Chart 91 shows that this top
down relationship with industrial production and survey measures of production
expectations may be as good an indicator of investment trends as any.
Chart 90: Investment often follows industry capacity utilisation Chart 91: Industrial surveys can give a more timely steer
5 8 20
Ppts % yoy
4 6 15
Total investment (% qoq)
Capacity Utilisation (change on prev qtr)
3 4 10
2 2 5
1 0 0
0 -2 -5
-1 -4 -10
-2 -6 -15
Total investment Industrial production Industrial production excl production

-3 -8 -20
1991 1994 1997 2000 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
79 UBS Warburg
Capital goods output
Overview EU12 Capital goods output

Normal publication date: 18th to 21st Market focus na
Normal publication lag: 7 8 weeks Units % mom sadj, % yoy wda
Coverage: EU12
Source: UBS Warburg
Description The data on euro area capital goods and construction output are collected as part of
the process of producing industrial production data. The data on capital goods
production is released as part of the main industrial production release typically
some seven to eight weeks after the end of the month to which it refers.
The data have a short history and are available since January 1995. Eurostat present
annual growth rates in working day adjusted form, while month-on-month
comparisons are based on seasonally-adjusted data. The data measure activity in the
capital goods producing sector in constant value-added terms at factor cost (ie,
excluding taxes and subsidies).
Capital goods data include the output of the motor vehicle industry as well as the
output of office machinery and equipment and communications equipment.
Construction output
Overview EU12 Construction output

Normal publication date: n/a Market focus Na
Normal publication lag: 12 weeks Units % mom sadj, % yoy wda
Coverage: EU9
Source: UBS Warburg
Description The data on construction output is collected as part of the process of producing the
main industrial production data. However, the absence of reliable data on the
construction sector for Portugal, Greece and Ireland, means that the statistics only
cover the remaining nine member states.
Although collected as part of the industrial production exercise, the resulting series
on construction output is not covered in the main press release and is not covered in
a separate press release. One of the reasons is that three member states only collect
data on construction activity on a quarterly basis. And the construction output series
for any given reference month is available only some five weeks after the main
industrial production series.
The construction output data measures activity in the sector in constant value-added
terms at factor cost (ie, excluding taxes and subsidies) and goes back as far as
January 1990.
80 UBS Warburg
Construction confidence survey
Overview EU12 Construction confidence

Normal publication date: 1st week of month Market focus Construction confidence
Source: UBS Warburg
Description The construction confidence survey is produced and published at the same time as
the European Commission surveys on industrial, retail and consumer confidence. It
appears in the Commissions Economic Sentiment Indicator with a weight of 20%.
In common with the other surveys, it should be borne in mind that the construction
confidence survey is a subjective measure of conditions in the sector rather than a
direct measure of value-added activity.
The survey consists of four questions covering recent activity, order book
assessments, employment, and pricing intentions. In addition, the Commission
derives an overall confidence series. The series has existed in consistent form since
January 1985 and is conducted monthly in each member state.
Methodology The construction confidence data is gathered from responses of a monthly telephone
survey carried out by national statistical agencies or polling organisations.
Each question in the survey has three possible answers, one positive, one neutral
and one negative. The results for each question are reported as simple percentage
balances where the percentage of respondents giving negative responses is
subtracted from the percentage of respondents giving positive answers. Neutral
responses are discarded. The overall confidence indicator is the simple unweighted
average of the responses to the employment and order book assessments.
Chart 92: Reported construction activity and construction investment
8 15
% yoy % balance
10
6
5
4
0
2
-5
0 -10
-15
-2
-20
-4
Correlation coefficient = 0.45 -25
-6
-30
Construction investment (lhs) Reported construction output (rhs)
-8 -35
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
81 UBS Warburg
Euro Area Data Decoder March 2003 CONSUMER SPENDING
Chapter 8: Consumer Spending

Consumer spending is the Consumption spending by private households is the largest single component of
single largest component of GDP and is a key driver of aggregate economic activity. As a rule, consumer
GDP spending accounts for between 55% and 60% of GDP in euro area economies Chart
93. In terms of economic growth, consumption typically accounts for between one-
third and one-half of annual GDP growth (Chart 94).
Yet consumer spending data Comprehensive data on household consumption is published quarterly as part of the
are only available once euro area national accounts. Higher frequency measures of consumer activity on
a quarter which we rely to assemble a picture of developments during the quarter fall into
two camps. Retail sales and new car registrations are direct measures of consumer
spending, while measures of consumer and retail confidence measure sentiment
rather than activity.
Table 27: High frequency indicators correlation with annual consumer spending growth
Consumer New car

Retail sales Retail confidence confidence registrations
Correlation coefficient 0.86 0.80 0.60 0.32
Source: UBS Warburg
Retail sales data have a high Retail sales data is the closest proxy among the high frequency indicators for
correlation with consumer aggregate private consumption. But the retail sales data excludes all consumption of
spending despite excluding services, as well as consumption of cars and petrol, meaning that it accounts for
services... around 40% of total private consumer spending (see Chart 95). As a result of this
relatively narrow coverage, the series tends to be much more volatile than total
consumption. Despite the fact that the data is seasonally adjusted, it is rare for the
month-by-month changes in the index to have the same sign of more than three
months in a row. The average absolute change in the annual growth rate since the
series inception in 1995 has been 1.1 percentage points. All this makes it difficult
to identify changes in the underlying trend in the series.
...but suffers from a long Table 27 shows that despite the narrow coverage, the retail sales series has a high
publication lag and high correlation with total consumer spending. A rise (or fall) in retail sales growth over
volatility the quarter, is typically accompanied by a rise (or fall) in consumer spending
growth 86% of the time. But the major problem with the retail sales data as a high
frequency measure of consumer spending is the publication lag. Data for any given
month are typically published with a 9-10 week time lag, much the same as the
official national accounts data. This delay is a serious limitation on the datas use as
a high-frequency activity measure.
The other direct measure of consumer activity, car registrations, is released on a

much more timely basis than the retail sales figures. However, since cars account
for only 5% of total consumer spending, it is difficult to draw any clear conclusions
about total spending from the car registration data. This is reflected in the low
correlation between annual growth in car registrations and total consumer spending.
82 UBS Warburg
Chart 93: Consumer spending more than 50% of GDP Chart 94: Consumption accounts for 30-50% of GDP growth
59.0 5.0
Per cent Consumer spending (share of GDP, nominal) % yoy
58.5
4.0
58.0
57.5 3.0
57.0
2.0
56.5
1.0
56.0
55.5 0.0
55.0
-1.0
54.5
Contribution of rest of GDP Contribution of private consumption GDP growth
54.0 -2.0
1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Source: European Commission, UBS Warburg Source: Datastream, UBS Warburg
Chart 95: EU12 Consumer spending by purpose Chart 96: Retail sales a very volatile indicator
Financia l services 6
Miscellaneous Per cent Euro area retail sales volume
0%
Insurance 6% Food
2% 16% 5
Restaurants & hotels % mom, sa % yoy, nsa
9% 4
Education Alcoholic &, tobacco
1% 4% 3
Recreation & cult ure
9% Clo thing & footwear
2
8%
Communications 1
2%
Petrol
4% 0
Motor vehicle s Housing & utilities
5% 15%
-1
Transport services
7% Health Furnishings, household
4% goods -2
8% 1996 1997 1998 1999 2000 2001 2002
Source: Eurostat, UBS Warburg Source: Datastream, UBS Warburg
Chart 97: Consumer confidence and consumer spending Chart 98: Retail confidence and consumer spending
5 5 10 5.0
% balance % yoy % balance % yoy
Consumer confidence (lhs) Consumer's expenditure (rhs) Retail confidence (lhs) Consumer's expenditure (rhs)
0 4 4.0
5
-5 3 3.0
0
-10 2 2.0
-5
-15 1 1.0
-10
-20 0 0.0
-15
-25 -1 -1.0
Correlation coefficient = 0.60 Correlation coefficient = 0.80
-30 -2 -20 -2.0

1985 1987 1989 1991 1993 1995 1997 1999 2001 1985 1987 1989 1991 1993 1995 1997 1999 2001
83 UBS Warburg
In terms of coverage, the retail confidence survey also by definition covers only
goods not services. In principle, however, the consumer confidence survey covers
attitudes towards the whole range of economic activity.
Retail and consumer surveys However, as measures of sentiment, there is always the risk that the surveys are
are more timely... impacted by external events that, in the final analysis, have little impact on
measured activity. Classic examples at the national level are elections, industrial
action or even success at major international sporting events.
Chart 97 and Chart 98 show how the two surveys have tracked real consumer
...and are useful guides to
spending growth in the euro area since the surveys inception in the mid 1980s.
consumer spending trends
Superficially the charts tend to suggest that the consumer confidence series provides
the better guide to the trends and levels of consumer spending growth. Yet the more
volatile and less frequently quoted retail confidence series has the higher correlation
with consumption growth over the sample. However, as Table 30 shows, the
responses to some of the individual questions from the consumer confidence survey
have a better correlation with private consumption growth than the headline index.
In particular, households perceptions of both their own finances and economic
developments over the past year have the highest correlation.
None of the above indicators give a consistently accurate picture of underlying

Combining the high developments in the consumer sector, but by bringing the information from the high
frequency indicators into frequency indicators together in a formal way, it is possible to build up a reasonably
simple models can be fairly accurate picture of developments during the course of a quarter. UBSW uses two
successful models to do this one based on German and French retail sales as well as euro
area car registrations. The other is based purely on survey data and combines series
from the consumer and retail confidence surveys. More details on the survey-based
model are given in the discussion of the UBSW monthly GDP model (page 61).
Again neither model is a completely reliable guide to the quarter-by-quarter

movements in consumption but do broadly capture the main trends and turning
points. Although the retail sales based model has a slightly lower average error, it is
more volatile and the data underlying it lags the survey data by some three to four
weeks.
Chart 99: Survey based model of consumption growth Chart 100: Retail sales based model of consumption growth
5.0 4.0
% yoy Consumers' expenditure Average absolute error 0.17 ppts % yoy Average absolute error 0.30 ppts
3.5
4.0
3.0
3.0 2.5
2.0
2.0
1.5
1.0
1.0
0.5
0.0 0.0
-0.5
-1.0
Error Actual UBSW Survey based model -1.0
Error Private consumption Retail sales-based model
-2.0 -1.5
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1994 1995 1996 1997 1998 1999 2000 2001 2002
84 UBS Warburg
EU12 Consumer confidence
Overview EU12 Consumer confidence

Normal publication date: 1st week of month Market focus Consumer confidence
Source: UBS Warburg
Description The European Commissions survey is the only genuine euro-area-wide measure of
consumer confidence. The survey is not a direct measure of consumer activity, but
rather of consumer sentiment. The consumer confidence indicator has a 20% weight
in the Commissions Economic Sentiment indicator.
The eleven questions, which comprise the survey, cover the state of the economy,
unemployment, household finances, inflation perceptions, as well as intentions
regarding big-ticket purchases and savings. Six questions are forward-looking,
while five are backward-looking. The questions are reproduced in Table 29.
The consumer confidence balance receives the most attention, though some of the
detailed components of the survey actually have a higher correlation with annual
consumer spending growth (See Table 30). Since September 2001, the headline
index has been calculated as a simple arithmetic average of the responses to
questions on the future prospects for household finances, the general economic
outlook, unemployment and savings. (Questions 2, 4, 7 and 11 in Table 29). The
previous version was an average of questions 1-4 and question 8.
Methodology The consumer confidence survey dates back to 1972, but was initially a quarterly
exercise available for five economies - Germany, France, Italy, the Netherlands and
Belgium. A full, comparable monthly survey for each member state is available
from January 1985, (July 1986 for Spain).
The consumer confidence indicator is constructed from the responses of a monthly

telephone survey (conducted by national statistics or polling organisations on the
Commissions behalf) in every member state bar Luxembourg. In total, some
19,000 consumers are polled each month, 1,500 in each of the smaller countries,
2,000 in France, Italy and Spain and 2,500 in Germany. The survey is carried out
between the first and 10th day of each month.
EU12 Consumer confidence
Average level -11 The responses are presented as % balances (the difference between the percentage
Highest level +2 of respondents giving a positive and a negative response). `Dont know responses
Lowest level -29 as well as those that indicate no change are discarded. The survey allows a range of
Month-on-month changes responses: positive (p), more positive (pp), negative (n) and more negative (nn).
Mean 1.1 The responses are weighted as follows:
Mode 1.0
% balance = (1 * PP + 0.5 * P) (0.5* N + 1 * NN)
Largest +7.0
Smallest 0.0 To derive the EU12 aggregates, the responses from individual member states are
Source: UBS Warburg
aggregated using the shares of private consumption in the euro area total as weights.
85 UBS Warburg
Table 29: European Commission consumer confidence survey: the questionnaire

Q1 How does the financial position of your household now compare with Q7 How do you think the level of unemployment in this country will change
what it was 12 months ago over the next 12 months?
PP Got a lot better N Got a little worse PP Increase sharply N Fall slightly
P Got a little better NN Got a lot worse P Increase slightly NN Fall sharply
= Stayed the same 0 Dont know = Remain the same 0 Dont know
Q2 How do you think the financial position of your household will change Q8 Do you think that there is an advantage for people to make major
over the next 12 months? purchases (furniture, washing machines, TVs etc.) at the present time
PP Get a lot better N Get a little worse P Yes, now is the right time
P Get a little better NN Get a lot worse = It is neither the right time nor the wrong time
= Stay the same 0 Dont know N No it is the wrong time, the purchase should be postponed
0 Dont know
Q3 How do you think the general economic situation in this country has Q9 Over the next 12 months, how do you think the amount of money that
changed over the past 12 months? you spend on major purchases will compare with what you spent over
the last 12 months? Will it be:
PP Got a lot better N Got a little worse PP Much more N A little less
P Got a little better NN Got a lot worse P A little more NN Much less
= Stayed the same 0 Dont know = About the same 0 Dont know
Q4 How do you think the general economic situation in this country will Q10 In view of the general economic situation, do you think this is:
develop over the next 12 months?
PP Get a lot better N Get a little worse PP A very good time to save
P Get a little better NN Get a lot worse P Quite a good time to save
= Stay the same 0 Dont know N Rather an unfavourable time to save
NN A very unfavourable time to save
0 Dont know
Q5 Compared with what it was 12 months ago, do you think the cost of living Q11 Over the next 12months, how likely are you to be able to save any
is now: money?
PP Very much higher N About the same PP Very likely

P Quite a bit higher NN Lower P Fairly likely
= A little higher 0 Dont know N Fairly unlikely
NN Very unlikely
0 Dont know
Q6 By comparison with what is happening now, do you think that in the next
12 months:
PP There will be a more rapid increase in prices

P Prices will increase at the same rate
= Prices will increase at a slower rate
N Prices will stay about the same
NN Prices will fall slightly
0 Dont know
Table 30: Correlation coefficients: consumer confidence components and EU12 annual consumer spending growth
Consumer confidence 0.60 Prices - last 12m -0.36

Household finances last 12m 0.76 Prices next12m -0.16
Household finances next 12m 0.70 Savings now -0.38
Economy last 12m 0.80 Savings next 12m 0.37
Economy next 12m 0.63 Major purchases - now 0.73
Unemployment next 12m -0.55 Major purchases next 12m 0.74
Source: UBS Warburg; Sample (1985Q1 to 2002Q1)
86 UBS Warburg
National consumer confidence measures
Overview Germany France Italy Netherlands

Published by: ICON Brand Navigation INSEE ISAE CBS
Frequency Monthly Monthly Monthly Monthly
Publication date 20-25th of month 1st week of month Last week of month Last week of month
Publication lag 4 weeks 1 week None None
Units Index 100=neutral Diffusion index Diffusion index % balance
Series starts 1986 1987 1980 1972
Sample size 2,000 2,000 2,000 1,000
Market importance Low Low Low Low
Source: UBS Warburg
Description In addition to the European Commission survey of consumer confidence, three of

the five major euro area economies also publish their own national surveys. The
exceptions are Germany and Spain. Although a consumer confidence series is still
published for Germany by ICON Brand Navigation, they now simply reproduce the
German component of the Commission survey. Since it is also published after the
EC survey, it is of little interest to financial markets.
As a rule, the national confidence series have a high correlation with the
corresponding national components of the EC harmonised survey and with
aggregate EU12 consumer confidence. Furthermore, the national consumer
confidence surveys are published in advance of the European Commission figures.
Yet despite this they are accorded a relatively low priority by markets.
Methodology In each case, the organisation that publishes the national survey is also responsible
for collecting the data for the European Commission harmonised survey and the
raw data on which the EC and national surveys are based is the same. However,
some national institutes namely INSEE also collect supplementary data for their
own purposes. In addition, the national institutes use different responses from the
raw data set to derive their own consumer confidence series. The composition of the
various consumer confidence indices is summarised in Table 31.
Table 31: Composition of consumer confidence series Chart 101: National confidence measures: a useful preview?
Component EC INSEE ISAE CBS 1.10

Correlation of national consumer confidence measures:
Economy Past 9 9 1.00 with own national component of EC survey with EU 12 consumer confidence
Outlook 9 9 9 9 with EU-12 consumer spending
0.90
Household finances Past 9
0.80
Outlook 9 9
Unemployment Outlook 9 9 0.70
Savings Present 9 0.60
Outlook 9 9 0.50
Major purchases Present 9 9
0.40
Living standards Past 9
0.30
Outlook 9
INSEE ISAE CBS
Household budget Present 9 9
Source: UBS Warburg
Source: UBS Warburg
87 UBS Warburg
Retail sales
EU12 retail sales
Normal publication date: 28-1st Normal transformation % mom sa, % yoy wda
Normal publication lag: 8 9 weeks
Source: UBS Warburg
Description Euro area retail sales data for the EU12 aggregate and the individual member states
have only been published since April 2000 although a back history for the series has
been calculated to January 1995.
Chart 102 below shows that, broadly speaking, retail sales growth and private
consumption move together, but that the retail sales data is far more volatile. And as
Chart 103 shows, the gap between the quarterly growth in retail sales and private
consumption is typically quite large. Given the data covers less than half of total
Table 32: Sector weights for EU12 consumer spending, this is scarcely surprising.
Food, beverages, tobacco 42.4 However, a more serious limitation of the series is its long publication lag the data
- specialised stores 35.0 is typically published eight to nine weeks after the period to which is relates. This
- non specialised stores 7.5 means that we receive official national accounts estimates for private consumption
Non-food 57.6 for any given quarter before we have the full quarters retail sales data.
- textiles, clothing, footwear 11.4
- household goods 14.6 The series covers the consumption of goods (including second hand), but excludes
- books, newspapers other 11.5 motor vehicles and fuel as well as all services (including repairs). As a result, the
- pharmaceutical & medical gds 8.5
series covers around 40% of total private consumption spending in the euro area.
- other non-specialised store sales 4.6
The data are expressed in constant 1995 prices. In deflating nominal turnover data,
- mail order 2.8
retail prices are measured as transaction rather than list prices. In other words,
Source: Eurostat taxes, transportation costs as well as any discounts are reflected in the deflator
series. The EU12 data are compiled from raw working-day-adjusted data provided
by national statistical bodies. The raw data are aggregated to produce a single euro
area statistic and this is then seasonally adjusted by Eurostat.
Chart 102: Retail sales captures trends in consumption... Chart 103:..but is not a good guide to quarter by quarter
changes
4.5 1.6
% yoy % qoq
4.0 1.4
3.5 1.2
3.0 1.0
2.5 0.8
2.0 0.6
1.5 0.4
1.0 0.2
0.5 0.0
Private consumption Retail sales
0.0 -0.2
EU12 Private consumption EU12 Retail sales
-0.5 -0.4
1996 1997 1998 1999 2000 2001 2002 1996 1997 1998 1999 2000 2001 2002
Source: Datastream/UBS Warburg Source: Datastream/UBS Warburg
88 UBS Warburg
In addition to the harmonised Eurostat data, each of the five largest euro area
member states produce data on retail sales. Both France and the Netherlands
produce more broadly based household consumption figures. In France, the
household consumption figures, which cover the consumption of manufactured
goods (including motor vehicles, though an ex-vehicle series is also available), are
the primary short-term indicator of consumer spending. In the Netherlands, despite
the fact that the household consumption data includes consumption of services as
well as goods, the retail sales figures are the most commonly cited due to their
shorter publication lag.
While the data are an asset to analysing the trends in private consumption on a
national basis differences in the way they are compiled and presented make cross
country comparisons and conclusions for the wider euro area aggregate difficult to
draw. For example, while Germany and the Netherlands both provide value and
volume data, this is not typical. France presents just volume series, while Spain and
Italy release only value series. Another major difference is that sales of alcohol and
tobacco are excluded from the Italian retail sales data but are included in the data
for other member states.
Germany France1 Italy Spain N/lands

Published by DeStatis INSEE ISTAT INE CBS
Headline series:
- Value or Volume Val & Vol Vol Val Val Val & Vol
- Incl or excl vehicles excl incl excl excl excl
- sa, wda, nsa sa/nsa sa nsa nsa nsa
Frequency M M M M M
Publication date 3-10 th 20-25th 24-31st 6-12 th 3-10 th
Publication lag 6-7 weeks 4 weeks 7-8 weeks 6-7 weeks 6-7 weeks
Series starts 1950 1978 1971 1995 1994
Market importance Low Medium Low Low Low
Source: UBS Warburg, 1. For France the series is household consumption of manufactured goods
New Car Registrations

There are two sources of car registration data. The first is from the Brussels based
European Automobile Manufacturers Association (ACEA) an organisation
representing 13 European car and truck manufacturers. The ACEA collate and
publish information provided by national vehicle manufacturing associations. The
data is monthly and is typically published in the middle of the following month. It is
expressed in numbers of vehicles and is neither seasonally, nor working day
adjusted. National associations also typically release their own national statistics in
the early part of the month.
In addition, Eurostat also provide a series for new car registrations. It is based on
the same raw data but is seasonally adjusted and presented in index form. There is
no formal release date and the data is not normally accompanied by a press release.
However, it typically lags the ACEA data by around four to five weeks.
89 UBS Warburg
Retail confidence survey
Overview EU12 Retail confidence survey

Normal publication date: 1st week of month Market focus Retail confidence
Coverage: EU12, All Member States
Source: UBS Warburg
Description The European Commissions survey of retail confidence goes some way to filling
the gap left by patchy and often quite out of date figures on retail activity that are
typical of the euro area. The retail confidence indicator has a 20% weight in the
Commissions Economic Sentiment indicator.
As with the consumer survey, the responses provide a qualitative guide to sentiment
in the sector rather than a direct measure of activity. There are five questions,
covering the present and future business climate, stock levels as well as
expectations regarding the future evolution of orders and employment. The
questions are reproduced in Table 34.
In terms of its press and market focus, the retail confidence indictor is very much
the poor cousin of the more widely quoted consumer confidence series. However,
the retail confidence indicator has a considerably higher correlation with annual
consumer spending growth. A correlation coefficient of 0.80, compares with a
coefficient of 0.60 for consumer confidence.
Methodology The retail confidence aggregate is derived as the simple arithmetic average of the
responses regarding the current and future business conditions and the current level
of stocks. The latter enters the calculation with a negative sign since a higher
reading in this series reflects an assessment that stock levels are too high and
(implicitly) demand levels too weak.
The retail confidence survey has a slightly shorter history than the consumer
confidence survey. The survey has been conducted regularly in Belgium, Germany
and France since the beginning of 1984 with participation extending gradually to
the other member states. For the larger Member States, data is available from July
EU12 Retail confidence 1986 (Oct 1988 for Spain).
Average level -6
Highest level +7 The survey draws on a sample that covers all member states except Luxembourg.
Lowest level -21 The questionnaires are completed between the first and 10th of each month.
Month-on-month changes
Mean 2.4 The survey is presented in terms of % balances (the difference between the number
Mode 1.0 of respondents giving a positive and a negative response). Neutral, or unchanged
Largest +9.0
responses are discarded. In order to generate the euro area aggregates, the country
balances are weighted using national shares of consumption in the EU12 total.
Smallest 0.0
Source: UBS Warburg
90 UBS Warburg
Table 34: European Commission retail confidence survey: the questionnaire
Q1 We consider our present business (sales) position to be: P Good

= Satisfactory (normal for the season)
N Bad
Q2 We consider our present stock to be: P Too large
= Adequate (normal for the season)
N Too small
Q3 We expect that out orders placed with suppliers over the next (t3) months, excluding purely seasonal variations will be: P Up
= Unchanged
N Down
Q4 Our business trend over the next six months, excluding purely seasonal variations, will: P Improve
= Remain unchanged
N Deteriorate
Q5 In the next 3 months, and compared with today, the number of persons we employ will: P Increase
= Remain unchanged
N Decrease
Chart 104: Retail confidence and retail sales growth Chart 105: Retail confidence and consumer spending
4.5 10 5.0
% balance Retail confidence Retail sales % yoy % balance % yoy
4.0 Retail confidence (lhs) Consumer's expenditure (rhs)
4.0
3.5 5
3.0 3.0
0
2.5
2.0
2.0
-5
1.5
1.0
1.0
-10
0.5 0.0
0.0 -15
-1.0
-0.5 Correlation coefficient = 0.80
-1.0 -20 -2.0

1993 1995 1997 1999 2001 1985 1987 1989 1991 1993 1995 1997 1999 2001
Chart 106:Retail sales and consumer confidence Chart 107: Correlation with real consumption spending (%yoy)
5 10 0.90
% balance Consumer confidence (lhs) Retail confidence (rhs) % balance
0.80
0 5
0.70
-5 0 0.60
0.50
-10 -5
0.40
-11 -6
-15 -10 0.30
0.20
-20 -15
0.10
-25 -20 0.00

LR Averages
-0.10
-30 -25 Retail confidence Business Stocks Business Orders Employment
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 conditions - now conditions - future intentions
91 UBS Warburg
Euro Area Data Decoder March 2003 LABOUR MARKET
Chapter 9: Labour Market

At the euro area level, data on the labour market is patchy, with limited coverage,
limited back data and publication lags that tend to be long. Using national data to
produce crosscountry comparisons or weighted averages also poses problems
thanks to differing definitions, coverage and publication lags inherent in the
national series.
Structural issues in the European labour market

Europes labour markets are As well as having data limitations, the euro area labour market has a number of
well known for their well-known structural rigidities. Compared with the Anglo-Saxon world, euro area
inflexibilities labour markets seem plagued with monolithic rigidities. Moreover the Member
States face different challenges. The labour market is one area where national
differences are at their most pronounced. Many would argue that the concept of a
common euro area labour market is fundamentally misplaced with national labour
market structures displaying more differences than common features. To illustrate
this point, Chart 110 to Chart 115 present a few indicators that offer a partial insight
into how different national labour market structures across the region are.
But different national markets One obvious area where significant divergence in labour market structures occurs is
face different challenges in the employment ratios. Across the euro area as a whole, 62% of the population of
working age are actually employed. Once we take account of those actively seeking
work, this means that across the euro area there are some 65 million people of
working age who play no role in the labour market. But as Chart 110 shows,
employment ratios vary considerably, from just under 75% in the Netherlands to
just over 54% in Italy. The chart also shows that it is a failure to bring women into
the workforce that accounts for below average employment ratios in Italy, Greece
and Spain.
Another issue that varies greatly across Member States, is the success of the
unemployed in re-entering the labour market. Long-term unemployment can
sometimes be interpreted as a mismatch between available vacancies and the skills
base of the unemployed, and sometimes as a reflection of the generosity of the
social security system and its impact on job search incentives. Either way, the
incidence of long term unemployment across the euro area ranges from 50% or
more in Germany, Greece, Belgium and Italy, to 35% or less in the Netherlands,
Austria and Finland.
Meanwhile, high levels of unemployment among the under 25s is also a common
problem for most member states. At the euro area level, the under 25s are twice as
likely to be jobless as the over 25s, the problem of youth unemployment being
particularly chronic in Italy, Finland and Greece.
Nevertheless, the 1990s saw While it is easy to find fault with most euro area labour markets particularly if
some reform progress... you approach the subject from an Anglo-Saxon perspective the reality of the
labour market picture is more complex. The euro area labour market has changed
dramatically over the past decade. The best, but not only, example is provided by
the Netherlands where substantial progress has been made in liberalising the labour
market, most noticeably in bringing women into employment by actively
92 UBS Warburg
encouraging part-time working. The results of this reform are clearly apparent from
Chart 110 and Chart 112, as well as the fact that the Netherlands has one of the
lowest unemployment rates in the OECD let alone Europe.
reducing non-wage labour One area where some economies have made improvements in recent years has been
costs in reducing labour costs. In France, the employers social security contribution has
been cut several times during the 1990s, especially for low-paid workers. The base
of the `taxe professionelle 2 was gradually altered and payroll excluded, reducing
further the total labour costs for employers. At the economy level, this resulted in
the ratio of social security contributions to wage costs declining steadily, from
slightly more than 10% at the beginning of the 1980, to about 6% in recent months.
Some contracts restricted to young workers also resulted in much more attractive
labour costs.
breaking the link between Italy embarked in a similar direction abolishing `La scala mobile, the sliding-scale
prices and wages mechanism of the 1992 agreement allowing pay indexation to the inflation rate. The
1993 agreement determined that sectoral wage developments should be in line with
the planned inflation rate, while company-level wage bargaining should recognise
the companys overall performance. The 1998 agreement confirmed this system but
also demonstrated that, when the government fixes the planned inflation rate, it
should take into account the average European inflation rate. As a consequence of
the shift in the bargaining process, Italian unit labour costs increased on average
7.2% per year between 1984 and 1991 but since the 1992 agreement they have
gained only 1.9% per year on average.
Chart 108: France is an example of social contribution cuts Chart 109: Italy increasingly using more flexible contracts
11 12
% Social contributions / Wages % first beginning by type of employment contract
11
10 Part time
10 Apprenticeship
Training and employment
9
9
8
8 7
7
5
4
6 1995 1996 1997 1998 1999
1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
Source: INSEE Source: ISTAT
2
The `taxe professionelle is a tax levied on companies where liability has to date been
assessed based on the firms capital stock and total wage bill. The payroll element is
being gradually phased out.
93 UBS Warburg
Euro area labour market selected structural indicators

Chart 110: Higher female employment is the key to participation Chart 111: Labour costs are highest in Germany
25
70 Euro per hour
% Euro area employment rates
FIN
65 20
NL
P Hourly labour compensation

60
Employment rate - Women
GER A
15
F
55
EU12 IRL
B 10
50
45 5
ES %
IT GR
40
50 55 60 65 70 75 0
Employment rate - total GER B US FIN A NL EU12 UK F I IRL ES GR P
Source: Eurostat, UBS Warburg Source: US Department of Labor, Bureau of Labor Statistics
Chart 112: Flexible working patterns vary enormously... Chart 113: ...but their recent rise is reflected in lower job tenure
70 95 60
% of employment % of employees Job tenure is falling % of employees
60
85 50
50
75 40
Part-time Temporary contracts
Job tenure more than 2 yrs (lhs)
40
1995 2000
65 30
30
55 20
20
45 10
10 Job tenure less than 1 yr (rhs)
1995 2000
0 35 0
NL ES GER P F EU12 FIN B A IRL IRL GR EU12 GER F I ES NL B FIN GR IRL P
Source: Eurostat, UBS Warburg Source: European Commission, UBS Warburg
Chart 114: Many unemployed are jobless for over 1 year Chart 115: Youth unemployment is a widespread problem
4.0
70 Ratio
% Long term unemployment
3.5
60
% of unemployed out of work for more Youth unemployment/non-youth unemployment
than 12 months 3.0
50
2.5
40
2.0
30
1.5
20
1.0
10 0.5
0 0.0
I GR B GER EU12 P ES F NL A FIN I FIN GR B P NL F ES EU12 IRL A GER
Source: Eurostat, UBS Warburg Source: Eurostat, UBS Warburg
94 UBS Warburg
and improving flexibility in A second area of improvement has been increased flexibility of the labour market.
working patterns In France, the use of temp agency workers or part-time work has been increasingly
used to circumvent the stringent labour laws. Legislation was also passed to allow
the ànnualisation of the working time. Firms exposed to seasonal activity can ask
their employees to work up to 48 hours per week without paying overtime provided
that the average working week over the year does not exceed 35 hours. This effort
was not confined to just France: Italy also legalised temp agency work at the end of
the 1990s, but also relied on part-time jobs and apprenticeships. The Berlusconi
government planned ambitious labour market reforms in order to boost further
flexibility, but little progress has been made to date. Furthermore, the weakness of
the government does not bode well for in-depth labour reform. Other countries in
Europe followed suit and the last OECD country reviews underline similar patterns
in Finland and Belgium as well as other countries. These two countries also
reported growth being more `job rich by the end of the 1990s.
Some measures have been A third area of improvement has been increasing labour supply. Poverty traps are a
taken to boost the labour common problem in the euro area. Since the unemployed benefit from high levels
supply of social transfers, the incentive to find a job paid at the minimum wage is limited.
In order to address these problems, France implemented a negative tax for low paid
workers in order to increase the incentive to work. Similarly, Italy cut labour
income taxes as a way of reducing the incentive for part of the workforce to remain
in the black economy. But the main problem is in the Netherlands: with an
unemployment rate as low as 2.4%, the need to increase the labour force is vital.
Result: more job creation The above is clearly only a limited overview of the kind of measures that have been
taken to address labour market rigidities in the euro area. It is clear that most euro
area economies have tried to address the structural issues over the past decade
although, to date, Germany stands out has having made only limited progress. As a
result, we believe that in the euro area the labour market has significantly changed
over the past decade or so as a result of reform efforts. One major change is that job
creation is higher for a given level of growth as highlighted in Chart 116. The other
side of the coin is that wages are less reactive to a change in inflation. This means
that real wages are becoming more flexible, which provides a buffer for firms.
These two changes are a clear sign that labour market flexibility has increased.
Chart 116: European growth has become more job-rich Chart 117: Nominal wage growth is more muted than before
3 8
% yoy Euro area earnings growth - much less responsive to inflation
y = 0.50x - 0.10
2
R = 0.26 7
2 '1990Q1 to '95Q4 y = 1.69x - 0.97
2
Civilian Employment growt
'1996Q1 to '02Q2 R = 0.84

6
Earnings growth
1 y = 0.56x - 0.95
2
R = 0.69
5
0
4
y = 0.36x + 2.11
-1 Job creation 2
1993Q4 to date 3 R = 0.29
growth thresholds
1981Q2 to 1988Q4
-2 2
0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5
GDP growth HICP inflation
Source: Eurostat Source: OECD
95 UBS Warburg
Euro area unemployment data

Euro area unemployment
Published by: Eurostat Series starts June 1990
Normal publication date: 1st week of the month Market focus Unemployment rate
Normal publication lag: 8 9 weeks Units % of labour force
Description Figures for euro area unemployment are published monthly by Eurostat typically
eight to nine weeks after the end of month to which they relate. The data are
typically not seen as market moving, due to the fact that national estimates from
each of the major member states will already be available by the time the euro area
figures are released. Eurostats press release covers both the unemployment rate and
the level of unemployment both in seasonally-adjusted terms. However, the focus
of the release is the unemployment rate. The Eurostat release also provides
estimates of the unemployment rate (but not level) in all twelve Member States on a
consistent harmonised basis. The accession of Greece to the single currency zone in
2001 has introduced a structural break in the data. Prior to January 2001, the data
cover the EU11. Post January 2001, the data cover the EU12.
Methodology The euro area data are compiled according to the ILO definition of unemployment,
which covers all those over 15 years of age. Among the major economies, only
France produces its national data on this basis, with the others basing the figures on
the number of registered unemployed. As a result, comparing the Eurostat and
national figures can be misleading.
The ILO uses three criteria to define unemployment. An individual must be: 1) out
of work; 2) be available to start work within the next two weeks and 3) have
actively sought employment at some point in the past four weeks.
The data is derived from the quarterly Community Labour Force Survey, with the
monthly figures interpolated and extrapolated using additional information from
national survey data and national figures on registered unemployment.
Chart 118: Unemployment rates vary widely across the EU12 Chart 119: Rates of change vary widely too
2.5
13
% Yearly Change in Unemployment Rate
%
2.0
12
1.5
11
1.0
10 0.5
0.0
9
-0.5
8
Euro area Germany -1.0
France Italy
7
-1.5
Euro area Germany France Italy
6 -2.0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Source: Eurostat Source: Eurostat
96 UBS Warburg
Other labour market data

In addition to the monthly unemployment series, Eurostat produce euro area data
for employment, hours worked, wages and salaries as well as labour costs. While
data on hours and on wages and salaries are only available for industry (excluding
construction), data for employment and labour costs have a broader coverage. All
the above indices are produced on a quarterly rather than monthly frequency (the
exception being the industrial employment index) and with a long publication lag.
In addition, none of the data are truly pan-euro area figures, as data limitations
among member states mean that they are based on a subset of the twelve countries.
Only the labour cost statistics are disseminated via a regular press release. As a
result, these additional labour market statistics have a low profile in financial
markets. The ECB also produce estimates of employment and of unit labour costs,
both of which are published in its ECB Bulletin.
Hours worked
The hours worked data is produced by Eurostat and covers the industrial sector
excluding construction and the main industrial groupings (energy, intermediate
goods, capital goods, consumer durables and non-durables). The data measures
aggregate hours worked in the industrial sector, including overtime but excluding
meal breaks, commuting time and paid holidays. The euro area aggregate is based
data for nine Member States. (Greece, Spain and Ireland do not provide data).
Wages and salaries

Wages and salaries data include all payments received by employees such as
bonuses, 13th month payments, severance pay, travel/lodging allowances, tips as
well as taxes and social security contributions withheld at source by employers.
However, payments to agency workers are not covered. The index covers only
industry excluding construction and a breakdown for the main industrial groupings
(energy, intermediate goods, capital goods, consumer durables and non-durables).
The data is compiled based on data submitted by Member States and the seasonal
adjustment is performed on the aggregated data. The euro area figures are based on
inputs from eight Member States (Greece, Ireland, Netherlands and Spain do not
provide data). Euro area aggregates must comprise at least 60% of the euro area.
97 UBS Warburg
Employment
EU12 Employment Eurostat ECB
Coverage Industry (ex construction) & some services Whole economy, industry, services
Frequency Monthly (industry) Quarterly (Services) Quarterly
Publication date None 10 15th of month
th
Data begins Jan 1990 (industry), Various (services) 1991 Q1
Source: UBS Warburg
Eurostat The employment indices compiled by Eurostat cover industry (excluding

construction) on a consistent basis and provide some data for six sub-sectors of the
service sector (retail, distribution including retail, hotels & restaurants, transport &
communication, financial intermediation and business services). The industrial data
are compiled on a monthly frequency, the service sector data quarterly. The data are
compiled on a headcount, rather than full time equivalent, basis. In other words,
part-time workers count as one employee rather than having their numbers scaled
by the hours that they work.
While the data on industrial employment cover all member states, (Greeces
membership from Jan 2001 introduces a structural break) the data on service sector
employment covers at most seven countries (retail) and in the case of business
services, as few as three. There are therefore no euro area aggregates except for the
retail sector. The industrial employment data begins in January 1990. The service
sector data is available over different periods depending on the country concerned.
ECB The employment data collected by the ECB is based on their own internal
calculations based on detailed Eurostat ESA(95) National Accounts data. As with
the Eurostat service sector data, coverage is partial, though the ECBs euro area
aggregates for whole economy, industry and services are based on coverage of at
last 80% of total euro area employment. The ECBs Monthly Bulletin presents
whole economy employment in index form although the underlying data in millions
is available from their website. Total employment can be disaggregated into
employees and self-employed, and into industry and services. However, the
disaggregated data is available only in annual growth rates and not in levels terms.
Chart 120: Eurostat and EBC data differ significantly Chart 121: ECB figures have a broader coverage
3.0 3.0
% yoy Euro area industrial employment estimates % yoy Contribution to euro area employment growth
2.0 2.5
1.0 2.0
0.0 1.5
-1.0 1.0
-2.0 0.5
-3.0 0.0
-4.0 -0.5
ECB Eurostat
-5.0 -1.0
-6.0 -1.5
Industry Services Total
-7.0 -2.0
-8.0 -2.5
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
98 UBS Warburg
Unit labour costs

EU12 Unit wage costs Eurostat ECB
Coverage Whole economy, Industry & Services Whole economy
Frequency Quarterly Quarterly
Publication date / Lag Ist week of month/5-6 weeks 10 - 15 of month/ 12 14 weeks
th th
Data begins Q1 1996 Q1 1992
Source: UBS Warburg
Eurostat The Eurostat data are published quarterly with provisional estimates released
some five to six weeks after the end of the reference quarter. Two further releases
are published, although the scope for revisions means that Eurostat never consider
the data to be `final. Historic data are based on data for all member states except
Greece (where no data yet exists). Provisional estimates cover 60% of the euro area.
The data measure the cost to employers of employing the labour force on an hourly
basis, including part-time or casual workers and including overtime. The data draw
a distinction between wages and salaries and other indirect labour costs including
employer social security contributions and taxes net of subsidies. Indirect costs do
not include items such as occupational training, canteens or recruitment fees. The
data cover all marketed economic activity and are available for the whole economy,
industry and service sectors. The figures exclude agriculture, public administration,
education and health. In addition, data on the service sector is missing or
incomplete for some economies including Germany, Austria and Ireland.
ECB ECB unit labour cost data measure the cost of employing the labour force on a per
head (rather than a per hour basis). The figures are published in the ECBs regular
Monthly Bulletin typically around the 15th of the month. They lag the reference
quarter by a full quarter. The data are split unit labour costs, into compensation per
employee and labour productivity, both at the whole economy level. Compensation
per employee is defined as wages and salaries plus employers social security
contributions. Labour productivity is defined as GDP per employed person.
Quarterly figures are derived from information for eight countries Belgium,
Ireland, Luxembourg and Portugal are excluded. Austria is excluded from the
labour productivity series. The data are not fully harmonised across Member States.
Chart 122: ECB and Eurostat data differ substantially Chart 123: Productivity, not pay, is driving ULC growth
6.0 10
Unit labour cost growth % yoy Unit labour cost growth
5.0
8
4.0 Labour productivity Compensation per head unit labour costs
6
3.0
2.0 4
1.0
2
0.0
0
-1.0
ECB Estimates Eurostat data
-2.0 -2
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Source: Eurostat, ECB, UBS Warburg Source: ECB, UBS Warburg
99 UBS Warburg
Euro area wage bargaining an overview

This section is dedicated to the wage rounds in the major euro area economies. The
process of wage bargaining varies greatly across the euro area, ranging from
centralised negotiation at one extreme to a full decentralisation of bargaining on the
other. Table 35 highlights these differences among EU members.
In general, wage growth in the euro area has been moderate recently. The challenge
in wage negotiations now is to make it a lasting process that simultaneously: 1)
allows for continued net employment (and thus output) gains, 2) maintains the
profitability of employment-creating investment and, 3) ensures consistency with
price stability. As a matter of principle, wage agreements should take into account
the existing differences in productivity with regard to qualification, sectors and
geographical areas. During a period of high unemployment, they should also ensure
that real wage increases do not fully exploit productivity increases.
Table 35: Wage bargaining levels in the European Union
Intersectoral level Sectoral level Company level

France X XXX
UK X XXX
Luxembourg XX XX
Austria XXX X
Germany XXX X
Italy XXX X
Netherlands XXX X
Portugal XXX X
Spain XXX X
Sweden XXX X
Greece X XXX X
Denmark XX XX X
Finland XX XX X
Belgium XXX X X
Ireland XXX X X
X = existing level of bargaining; XX = important, but not dominant level of bargaining; XXX =dominant level of wage
bargaining
Source: Thorsen Schulten and Angrlica Stueckler, Wage policy and EMU, EIRO June 2000.
The European continental model is characterised by a low level of organised labour

and an àrtificially high coverage of collective wage agreements through the
principle of erga omnes (a legislated geographical extension of collective wage
agreements) This is often a scenario of weak trade unions.
In Germany every year, collective wage agreements are settled for around 22
million German workers. The union IG Metall, which comprises 3.4 million metal,
electronics and automobile workers, has an informal leadership role in the
determination of compensation for the entire unionised workforce of Germany.
While the process of formulating proposals and strategies tends to begin months
before a contract expires, negotiations usually begin only shortly after the previous
contract has expired. These generally proceed without full-scale strikes, but in the
100 UBS Warburg

presence of demonstrations, `warning strikes may sometimes arise. The agreement

reached is usually regarded as a benchmark by other unions, which tend to mimic
the metal industry changes.
In France, there is no wage round and most of the wage negotiations are done at the
firm level. The only regular occurrence to watch is the revision of the minimum
wage every year in July. There is no fixed schedule for the revision of civil servant
compensation. France is an extreme case of the classical European model,
ideologically fragmented, yet the more militant trade unions can mobilise large
masses of unorganised labour quickly resulting in short-term strikes.
In Italy, wage negotiations for the private sector are still held at three different
levels, despite plans to change the procedure. First, wage increases are negotiated at
a national level for the following two years. Typically, wage increases at this level
of negotiation are in line with the governments inflation target. Once wage
increases are agreed at the national level, two further rounds of negotiations follow
at a sectoral level and at a firm level. The most relevant wage increases are usually
settled in the first months of the year but agreements are reached and revised
throughout the year.
In Spain, the bargaining system covers about 75% of firms and workers. Most of
the agreements are signed at the province-sectoral level (55%), followed by
national-sectoral agreements (28%) and firm-level agreements (14%). The
outcomes of agreements at the broader levels are accepted as de facto wage floors
for negotiations at narrower levels. As in Italy, the wage round is an ongoing
process of revision and new agreements at all the different levels and sectors. By
January, the main trade unions put forward a wage increase as a reference, which is
not necessarily followed by the sectoral and firm-level negotiations. Wage increases
in the state sector are set in the Budget during September.
In the Netherlands, wage negotiations formally take place at the sector level and
usually end in December. However, there is also an institutionalised interaction
between employers organisations and the unions. A guideline for negotiations at
the sector level is usually fixed at the national level by the end of September or
early October. The government has a limited intervention in this part of the wage-
formation process.
101 UBS Warburg

Euro Area Data Decoder March 2003 EXTERNAL TRADE
Chapter 10: External Trade

National accounts data cover Statistics on the euro areas external trade performance are published quarterly as
trade in both goods and part of the National Accounts. These show exports of both goods and services in
services value and volume terms as well as the net export position exports less imports
the key driver for GDP growth. In terms of deriving GDP, exports are added to
domestic demand growth as they are part of domestic production. But imports,
whose contribution to consumption, investment or stock building cannot be
identified separately, are subtracted to avoid double counting.
Additional higher frequency information on external trade is derived from the

visible trade statistics produced by Eurostat and from the Balance of Payments
(BOP) statistics compiled and published by the ECB.
High frequency visible trade The visible trade statistics are published around one week earlier than the BOP
data covers goods only statistics. But while the visible trade data relate only to trade in goods, the detail of
the current account of the BOP provides information on imports and exports of
services (around 20% of total euro area trade). Both series are reported in value
terms and without seasonal adjustment, though the ECB does provide estimates of
seasonally adjusted export and import volumes in its regular Monthly Bulletin. A
further difference between the two sets of data is that the BOP figures are compiled
on a purely extra-EU12 basis. The visible trade statistics on the other hand provide
figures on both intra and extra-EU12 trade flow.
the current account data Chart 124 shows that the extra-EU12 visible trade balance provides a reasonable
include trade in services proxy for net exports as measured by the national accounts. The breakdown in the
relationship in 1999 and 2000 reflects the combination of higher oil prices and a
depreciating currency, both of which boosted import prices. The value of imports
thus grew much more quickly than the volume of imports accounting for much of
the protracted decline in the visible trade balance.
The EUR12 has benefited Between 1991 and 2001 the volume of global trade in goods doubled Chart 125
from the 1990s world trade shows that although trade volumes in the euro area did not fully keep pace with the
growth expansion in world trade, trade flows nevertheless expanded rapidly, rising four
times faster than GDP over the period.
Chart 124: Visible trade a reasonable proxy for net exports Chart 125: External trade a growing source of wealth creation
60 220
EUR bn 1991Q1=100
50
200
40
180
30
20 160
10 140
0
120
-10
100
-20
Net exports Visible trade balance Current Account World trade volume EU12 imports EU12 exports EU12 GDP
-30 80
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
102 UBS Warburg

Though limited exposure to

Much of the expansion in global trade over the past decade reflects greater trade
flows to and from Asia. Table 36 shows the main export destinations for the EU12
Asia has given rise to a
aggregate and the 5 major economies. Asia, even when Japan is included, accounts
falling world trade share
for less than 15% of extra euro area trade less than both the UK and the US on
their own. This may be one reason why euro area trade grew more slowly than
global trade over this period.
Table 36: EU12 and major economies main trading partners (2001)
% of extra EU12 exports EU12 Germany France Italy Spain Netherlands

Other EU15 24.0 21.0 22.5 15.4 25.1 39.8
- UK 18.2 14.6 18.1 12.2 21.2 30.2
- Sweden 3.4 3.6 2.4 1.7 2.3 5.6
- Denmark 2.3 2.8 2.0 1.4 1.5 4.0
USA 16.6 18.5 16.1 17.8 11.1 11.7
Canada 1.4 1.4 1.7 1.7 1.1 1.1
Switzerland 6.2 7.7 6.6 6.7 2.5 4.2
Japan 3.2 3.6 2.9 3.2 2.4 2.8
Non- Japan Asia 10.4 11.1 10.7 10.8 6.6 9.8
- China 2.3 3.3 1.8 2.2 1.2 1.3
- Hong Kong 1.5 1.2 2.1 2.2 1.0 1.1
- Korea 1.1 1.2 1.1 1.2 0.8 1.2
Candidate countries 8.6 11.7 5.2 10.1 6.3 6.1
- Poland 2.9 4.1 1.8 2.9 2.3 2.8
- Czech Republic 2.3 4.1 1.1 1.5 1.5 1.4
Latin America 2.9 2.6 3.2 3.8 7.7 1.7
- Brazil 1.5 1.6 1.7 1.8 2.7 0.9
- Argentina 0.4 0.3 0.4 0.6 1.5 0.2
Middle East 5.6 4.4 6.2 8.4 6.8 4.8
Africa 4.7 2.7 9.9 4.9 7.8 3.5
Rest of World 16.6 15.4 15.0 17.2 22.6 14.4
- Russia 2.3 2.8 1.3 2.4 1.5 2.3
- Australia 1.0 1.0 0.7 1.3 0.9 0.7
Source: Datastream, UBS Warburg,
Candidate countries are: Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, Slovenia
As a share of GDP, imports and exports rose from 25% in 1991 to around 40% in early
2001. On average however, exports grew faster than imports meaning that net trade has
by and large been a positive force for GDP growth. Since the Q1 92, net trade has, on
average, added 0.3 percentage points to year-on-year GDP growth each quarter.
Chart 126: Net exports typically boost GDP growth Chart 127: Domestic demand has a strong import component
5.0 9
% yoy % yoy y = 2.48x - 2.55
2
4.0 R = 0.92
6
3.0
Annual growth in import volume
3
2.0
1.0 0
0.0
-3
-1.0
-2.0 -6
-3.0 % yoy
-9
Net exports Domestic demand GDP
-4.0 -2 -1 0 1 2 3 4 5
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Annual growth in final domestic demand volumes
103 UBS Warburg

The main exception to this was in the aftermath of the Asian crisis in 1998. The
As a rule, trade has been a
deterioration in the euro areas net trade performance in this period was, however,
net positive for EU12 GDP
less due to the sharp contraction in global trade, than the fact that domestic demand
growth in the 1990s
remained strong. Table 37 shows a breakdown of euro area trade in goods. Almost
two-thirds of euro area goods imports fall into the category of capital or consumer
goods. Chart 127 shows, as a result, that a simple bi-variate regression suggests a
one percentage point change in final domestic demand growth generates a
2.5percentage point change in import growth. Contrast the 1998 experience to the
post Q2 01 slowdown, where despite a larger contraction in world trade, net exports
have remained positive thanks to the sharp contraction in domestic demand and, as
a result, import growth.
Table 37: Euro area external trade in goods
Primary products Manufactured goods

Food & Crude Machinery & Other manuf
% of total
drink materials Energy Chemicals vehicles goods Other
Exports 6 2 2 13 47 27 3
Imports 6 5 14 9 38 25 3
Source: UBS Warburg, Datastream
For the EU12 however, intra as well as extra regional trade is important. Although
in principle the aggregate National Accounts data ought to exclude intra-euro area
trade flows, they do not in practice do so. In other words, the import and export
numbers reported as part of GDP include French exports to both Finland and Fiji.
Visible trade data show that intra and extra regional trade each account for around
50% of total euro area exports. Chart 128 shows that these figures vary markedly
across member states. And Chart 129 shows the importance of Germany in intra-
regional trade it receives 25% of all intra-euro area exports. Add in France and
Italy and these three economies absorb almost 60% of intra regional exports.
Finally, we are frequently asked how sensitive euro area trade flows are to changes
in the exchange rate. Unfortunately, there is no simple answer to this question, as
the economic impact of a currency shift depends on both the cause and the
underlying cyclical starting point of the economy. We therefore prefer not to deal in
simplified rules of thumb.
Chart 128: Intra-EU12 exports as % of total exports Chart 129: Share of intra-EU12 exports going to each economy
75 30
Per cent of total exports Per cent
70
65 25
60
20
55
50
15
45
40
10
35
30 5
25
20 0
PT NL BG ES AU EU12 FR IT BD IR GR FN BD FR IT BG ES NL OE PT GR FN IR
104 UBS Warburg

Visible trade balance
Overview EU12 Visible trade balance

Published by: Eurostat/ECB Series starts Jan 1995
Normal publication date: 19th to 23rd Market focus Visible trade balance
Normal publication lag: 7-8 weeks Units EUR billion, sadj, wda
Coverage: EU12 (EU11 pre Jan01)
Source: UBS Warburg
Description The primary source of visible trade statistics for the euro area is Eurostat, although
the ECB also publish visible trade statistics in the Monthly Bulletin. The Eurostat
figures cover imports and exports of goods (but not services) as well as the balance
of trade. The data are reported in current prices and the headline trade balance
figures are not seasonally adjusted although Eurostat also publish seasonally-
adjusted series. Volume series for imports and exports are calculated by the ECB
using Eurostat data for import and export prices.
The import and export data can be broken into primary products (food and drink,
raw materials and energy), manufactured goods (chemicals, machinery and vehicles
and other manufactured goods) as well as a residual òther category. The ECB
presents a narrower disaggregation into intermediate, capital and consumption
goods. An analysis by major trading partner is also available. Both the goods and
geographic breakdowns lag the headline figures by a month.
Methodology Eurostat visible trade statistics are collated from data provided by EU Member
States. Each state provides data on extra and intra EU trade. Initial estimates of
visible trade rely heavily on national non-harmonised data and Eurostat forecasts.
The data are therefore subject to revisions for up to two years after publication.
Exports (or dispatches for intra-EU trade) are measured f.o.b (free on board).
Imports (or arrivals for intra-EU trade) are measured c.i.f (including costs of
insurance and freight to the importers border).
National statistics for visible trade and those produced by Eurostat are not directly
Table 38: EU12 external trade balance comparable. One reason for this is definitional and methodological differences and
EUR bn (2001)
in particular the treatment of goods in transit. Eurostat gives the following example.
If goods from a non-EU Member State (say Japan) were to be imported to France
Primary products -143.0
via the Netherlands, Eurostat would record three transactions: an import from Japan
- Food & drink 6.2
by the Netherlands; an export to France from the Netherlands and an import from
- Crude materials -28.6
the Netherlands by France. But Dutch national statistics would not record the trade,
- Energy -120.7
while France would record an import from Japan.
Manufactured goods 154.4
- Chemicals 51.3 Since the inception of intra-EU trade statistics, exports (dispatches) have
- Mach & vehicles 13.1 consistently been larger than imports (arrivals). Since arrivals are recorded c.i.f. and
- Other man gds 89.9 dispatches f.o.b. the reverse ought theoretically to be true. In 2001, the discrepancy
Other -4.0 amounted to 6% of intra-EU trade. Eurostat regard dispatches data as more reliable.
Total 7.4 This discrepancy means that the euro area aggregate trade balance (which includes
trade with Sweden, Denmark and the UK) is not regarded as particularly reliable.
Source: UBS Warburg
105 UBS Warburg

Balance of Payments
EU12 Balance of Payments
Overview
Published by: ECB Series starts Jan 1997
Frequency: Monthly/Quarterly Market importance Low
Normal publication date: 22nd to 29th Market focus Current account balance
Normal publication lag: 8-9 weeks Units EUR billion
Coverage: EU12
Source: UBS Warburg
Description The balance of payments statistics are a measure of the economic transactions of the
euro area with the rest of the world and a record of how those transactions are
funded. The statistics are compiled and published by the ECB. The balance of
payments comprises the current account, the capital account and the financial
account. The balances and their sub-components are described below. The headline
statistics are reported in value terms and are not seasonally adjusted. (The current
account data are also available on a seasonally-adjusted basis.)
The Current Account
This is the primary focus of the balance of payments release for monitoring the
external trade performance of the euro area. The current account comprises.
The goods balance covers the net trade in goods between the euro area and the
rest of the world. The figures do not match the Eurostat visible trade data as
imports are valued on a f.o.b. (free on board) basis at the exporters border. The
visible trade balance is normally in surplus.
The services balance covers trade in transport, travel, communication,

insurance and financial services. Services account for 20% of euro area trade.
Deficits and surpluses are typically small, ranging from EUR +5 to 5 billion.
The income balance records net earnings (both employment and investment) of
euro area residents from non-euro area employers and assets. Net income
generated by interest rate derivatives is recorded in the financial account. The
EU12 income balance typically records a deficit of 5-10 billion a quarter.
Chart 130: EU12 Balance of Payments overview Chart 131: EU12 Current Account breakdown
70 50
EUR bns EUR Bn
60
40
50
40 30
30 20
20
10
10
0 0
-10
-10
-20
-30 -20
-40 -30
-50
-40
-60
Current Account Captial Account Financial Account Errors & Ommissions Services bal Visible bal Income bal Transfers bal Current account balance
-70 -50
1998 1999 2000 2001 2002 1997 1998 1999 2000 2001 2002
106 UBS Warburg

The transfers balance records payments made by euro area residents for which
no goods and services are received, eg, food aid. Transfers of resources that will
be consumed over more than 12 months are recorded as capital transfers within
the capital account. Transfers normally show a 10-15 billion deficit.
The Capital Account
A measure of capital transfers, as well as the net sales of non-produced, non-

financial assets such as copyrights or land. Debt forgiveness would also be scored
here. The EU12 capital account is typically in small surplus.
The Financial Account:
A record of transactions associated with the net acquisition/disposal of euro area

residents financial assets/liabilities. The financial account records net flows of
foreign direct investment as well as portfolio flows.
Direct investment records the net acquisition by a resident in one economy of a
`lasting interest in an enterprise resident in another. A `lasting interest is
defined as a holding of 10% of more of the ordinary shares. Once established, all
subsequent financial flows between the entities are recorded as direct
investment. The EU12 typically records net outward investment each quarter.
Portfolio investment records transactions in equity and debt securities (other
than those defined as direct investment).
Financial derivatives transactions (options, futures,) are recorded separately,
not as part of the underlying transactions to which they may be linked.
Other investment covers such transactions as trade credits, loans currency and
deposits and other financial transactions not covered elsewhere such as capital
subscriptions by Member States to non-monetary international organisations.
Reserve assets record financial assets controlled by the ECB and NCBs. They
include monetary gold, Special Drawing Rights, foreign currency as well as the
reserve position of the institution with the IMF.
Errors and Omissions

The current, capital and financial accounts should sum to zero, but rarely do. Errors
can, at times, be as large as the main balances making interpretation difficult.
Chart 132: Financial Account Overview Chart 133: Capital flows and the exchange rate
300 100 1.25

EUR bn Direct investment Portfolio investment EUR bn
250
Financial derivatives Other investment 0 1.20
200
Reserves Financial balance
-100 1.15
150
100 -200 1.10

50
-300 1.05
0
-50 -400 1.00
-100
-500 0.95
-150
-600 0.90
-200 Cumulative direct and portfolio investment flows (lhs)
A positive figure represents a net acquisition of assets by euro area residents EURUSD (rhs)
-250 -700 0.85
1998 1999 2000 2001 2002 1997 1998 1999 2000 2001 2002
107 UBS Warburg

Euro Area Data Decoder March 2003 LEADING INDICATORS
Chapter 11: Leading Indicators

Lead indicators attract a lot of attention perhaps more than their track record
would suggest that they deserve. In this section, we analyse the properties of 10 of
the most commonly proposed lead indicators, ranging from single series to the
composite indicators produced by the OECD and by ourselves. Detailed description
of the data is confined to the OECDs composite leading indicator, the UBSW
turning point indicator and the related UBSW risk of recession indicator.
Turning points in the Chart 134 below shows that turning points in the economic cycle occur with
economic cycle occur with monotonous regularity. Between January 1986 and April 2002, we have identified
monotonous regularity nine clear turning points in industrial production growth, 11 if we include the
seven-month interruption in the growth slowdown between October 1991 and May
1992. On average, there is a turning point every 18 months. Yet despite the
frequency with which they occur, economists still struggle to predict them
consistently.
Yet economic forecasts One of the reasons for this is that most economic statistics are published with a
frequently fail to anticipate considerable lag. As a result, it is often hard enough to be confident about the
them accurately current pace of activity, let alone predict its future course. Furthermore, the impact
of external shocks to the economy, for example, shifts in the exchange rate or oil
prices, as well as changes in fiscal and monetary policy, are typically only reflected
in the pace of activity with a considerable lag. In the case of monetary policy, it is
widely accepted that the full effect of interest rate changes can take as long as two
years to be felt. Leading indicators can therefore be a useful input into the
forecasting process by providing advance notice of new trends in activity against
which economists can shape and verify their growth trajectories.
Lead indicators are a useful In the main, lead indicators are measured against their ability to predict turning
reality check for economic points in the industrial production cycle. Although only 20%-30% of GDP in
forecasts Europe, industrial production growth accounts for most of the cyclical variation in
GDP growth. As Chart 135 below shows, only in the early 1990s a period that
was distorted by German unification has there been a significant divergence in the
peaks and troughs in IP and GDP growth.
Chart 134: 11 turning points in IP since 1985 Chart 135: Turning points in IP and GDP are synchronous
8.0 8 5
% yoy Dec-94 Feb-98 % yoy % yoy
6.0 Feb-89 Dec-00 6 4
4.0 4 3
2.0 2 2
May-92
0.0 0 1
Jan-87 Jun-96 Apr-99
Oct-91
-2.0 -2 0
-4.0 -4 -1
Dec-01 IP (lhs) GDP (rhs)
-6.0 -6 -2
IP excl construction 3mma
Apr-93
-8.0 -8 -3
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003
108 UBS Warburg

Numerous series have been proposed as lead indicators for euro area activity. As
well as purpose-built indicators such as those produced by the OECD, series such as
the exchange rate, equity prices and real narrow money growth and business
confidence in the Belgian economy have been proposed.
Lead indicators can be single These indicators fall into two groups. The first are variables that tend to give early
series or composite signals of a change in the pace or direction of economic activity. This can be
indicators because they relate to the early stages of the value-added chain, (eg, order flow or
construction permits). Alternatively they result in a shift in relative costs that force
consumers and businesses to alter their behaviour (eg, changes in exchange or
interest rates). The second type combine a number of variables with lead-indicator
properties in order to derive a single indicator with more reliable and consistent
properties. The OECD produces the best known of these, though UBSW has also
developed our own Turning Point Indicator (TPI).
Their performance can be Chart 136 to Chart 145 plot 10 of the most useful indicators. In order to help
judged by their ability to distinguish between them,
anticipate turning points
Table 39 summarises their performance against three key criteria, namely: their success
rate for predicting turning points, the frequency with which they send false signals and
the extent to which the indicators provide a consistent predictive lead time..
Table 39 shows that four of our ten indicators (the UBSW TPI, the trade weighted
exchange rate, the US ISM survey and the expectations component of the German ZEW
survey) have a 100% track record in anticipating turning points in industrial production
growth. (Note that the ZEW survey begins in December 1991, so has a more limited
track record.) Of the remaining six series, each have missed at least one turning point,
either because they provided a signal only after the event (a lagging signal) or because
they provided no clear signal of a turning point at all.
and their failure to provide The incidence of false signals among our indicators is surprisingly scarce. Although
false signals defining a false signal inevitably requires a large amount of judgement, we can only
comfortably say that two of our ten indicators have warned of turning points that never
materialised. However both are among those with 100% hit rates, the German ZEW and
the US ISM surveys.
Our analysis suggests the In terms of signal consistency, we have provided two measures. The first simply counts
OECDs CLI and our own TPI the number of times the lead of the series over the actual turning point in industrial
have the best track record production, has fallen within the +/- 1 standard deviation band of the average lead for
successful signals (ie, excluding lagging signals). Statistically this should occur 64% of
the time. Our second measure shows the coefficient of variation of the lead times (the
standard deviation normalised by the average lead time.) A low figure indicates a tight
spread of lead times over the sample. Taking both measures together, our table shows
that three series, the UBSW TPI, the German ZEW series and the OECD CLI stand out
as providing the most consistent signals.
The purpose of the above discussion has not been to champion or discredit the
properties of any given indicator. We believe that reliance on any single indicator is
risky but the above analysis should provide a framework within which to interpret
moves in the commonly used lead indicators for the euro area.
109 UBS Warburg

Leading indicators for EU12

Chart 136: OECD composite lead indicator Chart 137: UBSW turning point indicator
8 12 8 6
% latest 3m 6 mth annualised change % latest 3m normalised std
on a year earlier on a year earlier devs 3mma
6 9 6
4
4 6 4
2
2 3 2
0 0 0 0
-2 -3 -2
-2
-4 -6 -4
-4
-6 -9 -6
IP excl constr'n (lhs) OECD lead indicator (rhs) IP excl constr'n (lhs) UBSW TPI (rhs)
-8 -12 -8 -6
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Chart 138: German Ifo survey: future minus current conditions Chart 139: German yield curve: 10y 3m rates
8 Index points 30 8 375

% latest 3m on % latest 3m Bps
a year earlier on a year earlier
6 25 6 300
No signal
4 20 4 225
2 15 2 150
0 10 0 75
-2 5 -2 0
-4 0 -4 -75
-6 -5 -6 -150
IP excl constr'n (lhs) IFO Future minus current conditions(rhs) IP excl constr'n (lhs) German 10y-3m (rhs)
-8 -10 -8 -225
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Table 39: Performance of alternative lead indicators of EU12 industrial production growth
Reason for miss Consistency of signal

Lagging False Average % within +/- Coeff of
Hits Misses Hit rate (%) signal No signal signals lead (mths) 1std Variation
UBS Turning point indicator 11 0 100 0 0 0 9 82% 0.42
Nominal trade weighted exch rate 11 0 100 0 0 0 8 55% 0.74
German ZEW expectations 7 0 100 0 0 1 5 86% 0.47
US ISM survey (manufacturing) 11 0 100 0 0 1 11 64% 0.78
OECD Composite lead indicator 10 1 91 1 0 0 6 73% 0.44
Ifo: future current conditions 10 1 91 1 0 0 10 55% 0.34
German yield curve (10y-3m) 9 2 82 0 2 0 15 36% 0.36
Real M1 growth 9 2 82 0 2 0 14 64% 0.36
Belgian business confidence 8 3 73 3 0 0 4 55% 0.73
European Equities 7 3 70 3 0 0 7 50% 0.61
Source: UBS Warburg
110 UBS Warburg

Lead indicators for EU12 (...continued)

Chart 140: Nominal trade-weighted euro Chart 141: Real narrow money growth (M1)
8 -15 8 14
% latest 3m % yoy, % latest 3m % yoy
on a year earlier inverted scale on a year earlier No signal
6 -10 6 12
4 4 10
-5
2 2 8
0
0 0 6
5
-2 -2 4
10
-4 -4 2
-6 15 -6 0
IP excl constr'n (lhs) Nominal trade-weighted exchange rate (rhs) IP excl constr'n (lhs) Real M1 (rhs)
-8 20 -8 -2
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Chart 142: US ISM manufacturing survey Chart 143: Belgian business confidence
8 62 8 10
% latest 3m index % latest 3m % balance
on a year earlier False signal(s) Lagging signals
on a year earlier
6 59 6 5
4 56 4 0
2 53 2 -5
0 50 0 -10
-2 47 -2 -15
-4 44 -4 -20
-6 41 -6 -25
IP excl constr'n (lhs) US manufacturing ISM survey (rhs) IP excl constr'n (lhs) Belgian business confidence (rhs)
-8 38 -8 -30
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Chart 144: German growth expectations (ZEW survey) Chart 145: European equity prices
8 100 8 60
% latest 3m False signal index % latest 3m on % latest 3m on
Lagging signals
on a year earlier a year earlier a year earlier
6 80 6 45
60
4 4 30
40
2 2 15
20
0 0 0
0
-2 -2 -15
-20
-4 -4 -30
-40
-6 -60 -6 -45
IP excl constr'n (lhs) ZEW econ sentiment, Germany (rhs) IP excl constr'n (lhs) European equity prices (rhs)
-8 -80 -8 -60
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
111 UBS Warburg

OECD Composite Leading Indicator

Overview OECD Composite leading indicator
Published by: OECD Series starts Jan 1962
Normal publication lag: 4-5 weeks Key transformation %6m annl change
Coverage: EU12 Industrial prodn No. of components 12 (91)
Source: UBS Warburg
Description The OECDs composite leading indicator (CLI) is designed to anticipate turning
points in the industrial cycle. On average, it predicts a peak or trough in industrial
production growth around six months in advance. The CLI is the natural choice for
cross-country comparisons as CLIs exist for each of the 22 OECD member
economies and all of the major OECD regions (G7, EU15, etc).
The CLI is presented as an index (1995=100), so many alternative transformations

can be made (% m/m, % y/y etc). The choice of whether we look at the month-on-
month or year-on-year change will affect both the timing and consistency of the
indicators signal. Although it is commonly presented as an annual rate of change,
the OECDs preferred transformation is the six-month annualised change.
Methodology The EU12 CLI is a weighted-average of individual CLIs for each Member State.
The current weights used to derive the EU12 aggregate are shown in Table 40.
On average, a country CLI has eight component series though Spain has just five
and the Netherlands has 11. There are 91 input series that feed into the 12 country
Table 40: EU12 CLI Weights CLIs that make up the EU12 aggregate (86 if we exclude series that appear in more
Country Weight (%) than one country CLI).
Germany 32.0
Italy 21.3
The series for country CLIs are selected according to three basic criteria. Firstly
France 18.4
there has to be an economic rationale why the series under consideration leads the
industrial cycle. Secondly, the series should have no missing or extra cycles
Spain 9.6
compared with industrial production and should ideally display consistent leads
Netherlands 4.9
over the whole cycle. Finally, the component series should pass minimum quality
Belgium 3.6
thresholds; ie, be monthly rather than quarterly, be easily available, have no breaks
Austria 2.8
in the time series and not be subject to frequent large revisions.
Portugal 2.7
Finland 1.7 To calculate the final index, the input series are smoothed and normalised to
Ireland 1.6 homogenise cyclical amplitude before being aggregated. Note that the component
Greece 1.3 series are not weighted in the aggregation process. The final selection of component
Luxembourg 0.2 series is designed to maximise performance against the industrial cycle, though as
EU12 100.0 broad a cross-section of activity as possible is included.
Source: OECD
Despite the quality thresholds on the data, the publication lags of the component
series mean that the first estimates of CLIs for any given month are necessarily
based on between 40% and 60% of the final observations. Thus the CLI is subject
to revision both as more complete data becomes available and as the component
series themselves are revised.
112 UBS Warburg

UBSW Turning Point Indicator
Overview UBSW Turning Point Indicator

Published by: UBSW Series starts Jan 1981
Frequency: Monthly Market importance None
Normal publication lag: 1 week Key transformation Normalised std devns
Coverage: EU12 Industrial prodn No. of components 4
Source: UBS Warburg
Description Like the OECD Composite Leading Indicator, the USBW turning point indicator is
designed to anticipate turning points in the euro area industrial cycle. The indicator,
which has been calculated back to January 1981, typically anticipates peaks and
troughs in industrial production growth by around nine months.
The indicator is presented in normalised standard deviation terms, and does not
need to be transformed into annual or monthly growth rates.
The TPI is calculated from just four input series making it something of a halfway
house between the single variable and more comprehensive OECD approach. The
use of more than one variable ensures that the risk of false or missing signals is
reduced. But the use of just four input series means it is easy to decompose changes
in the indicator into its components. Compared with the OECDs CLI, which has 91
input series, this is a clear advantage when it comes to interpreting the indicators
movements.
Methodology The UBSW TPI is calculated by combining four component series:
The German yield curve;

Future minus current conditions indices from the German IFO survey;
Real M1 growth (deflating nominal M1 by headline HICP inflation); and
The year-on-year change in the trade weighted euro exchange rate.
In selecting the input series to be used, the objective was purely to maximise the
performance of the indicator over as long a time period as possible. There was no
attempt to exclude variables on the basis of their performance as individual lead
indicators - just to maximise the predictive performance of the aggregate indicator.
For each series, the monthly deviation from a long run average is calculated and this
is then normalised around the long-run standard deviation. The four resulting series
are then summed without any additional weighting. The exchange rate term is
entered with a negative sign. The data are not smoothed any further.
As with the OECDs CLI, initial estimates for the TPI for any given month are
based on partial information. For the TPI, the publication lag of the monetary and
inflation data in the euro area means that provisional estimates are based on our
own assumptions for real M1 growth. Our standard practice is to assume that real
M1 growth remains unchanged from the previous month. Small revisions can
therefore be expected in subsequent months.
113 UBS Warburg

UBSW Risk of Recession Indicator
Overview UBSW Risk of Recession Indicator

Published by: UBSW Series starts Jan 1981
Frequency: Monthly Market importance None
Normal publication lag: 1 week Key transformation %
Coverage: EU12 Industrial prodn
Source: UBS Warburg
Description The UBSW Risk of Recession Indicator (RRI) is not a lead indicator in the normal
sense. Rather it attempts to use the UBSW TPI (discussed on the previous page) to give
some idea of the probability of `recessionary conditions in the industrial sector three
quarters into the future. So while the TPI can tell us about the timing of turning points,
the RRI attempts to distinguish between severe and less severe downturns.
Methodology The starting point for calculating the RRI is to define `recessionary conditions. We
define this as a three-month moving average of annual industrial production growth
below 0.5%. Although not the classic definition of a recession (two consecutive
quarters of negative growth), annual growth of less than 0.5% has normally been
accompanied by at least one quarterly decline in the level of industrial production.
Periods that fit the definition of recessionary conditions, are assigned a value of
one, all other periods are assigned a value of zero. A simple probit regression is
then estimated. The regression translates the TPI into the probability of state 0 (non-
recessionary conditions) or state 1 (recessionary conditions) existing.
The sample is dominated by the early 1990s recession, which means that comparing
relative peaks and troughs in the indicator, as well as its month by month movement
is more useful than the precise probability reading itself.
Chart 146: UBSW Risk of Recession Indicator

10.0 1.20
%, yoy,3mma %
8.0
Euro area industrial production (lhs) 1.00
6.0
4.0 0.80
2.0
0.60
0.0
-2.0 0.40
UBSW's Probability of Recession

-4.0
Index (9 month lead) (rhs)
0.20
-6.0
-8.0 0.00
Jan-86 Sep-87 May-89 Jan-91 Sep-92 May-94 Jan-96 Sep-97 May-99 Jan-01 Sep-02
Source: UBSW
114 UBS Warburg

Section 3: Appendices
115 UBS Warburg

Appendix 1: A Selective Guide to Euro Area Policy Makers
116 UBS Warburg

The European Central Bank Euro area governments
Name Nationality Role Member State Who leads the Government? Who is responsible for the Budget?
The Executive Board of the ECB Wolfgang Schsse Karl-Heinz Grasser
Austria
Chancellor Minister of Finance
Willem Duisenberg (retires 9 July 2003) NL President & Member of the Executive Board
Guy Verhofstadt Didier Reynders
Lucas Papademos EL Vice President & Member of the Executive Board Belgium
Prime Minister Minister of Finance
Otmar Issing GER Chief Economist & Member of the Executive Board Paavo Lipponen Sauli Niinist
Finland
Eugenio Domingo-Solans ES Member of the Executive Board
Jacques Chirac
Sirkka Hmlinen FIN Member of the Executive Board President Francis Mer
France
Tommaso Padoa-Schioppa IT Member of the Executive Board Jean-Pierre Raffarin Minister of Finance
The Governing Council of the ECB - Executive Board plus the Central Bank Governors/President of the 12 Member States Prime Minister
Gerhard Schrder Hans Eichel
Klaus Liebscher A Governoer, Oesterreichische Nationalbank Germany
Chancellor Minister of Finance
Guy Quaden B Governor, Nationale Bank van Belgi/Banque National de Belgique Constantine Simitis Nikolaos Christodoulakis
Greece
Matti Vanhala FIN Governor, Suomen Pankki Finlands Bank Prime Minister Minister of Economy & Finance
Bertie Ahern Charlie McCreevy
Jean-Claude Trichet F Governor, Banque de France Ireland
Taoiseach (Prime Minister) Minister of Finance
Ernst Welteke GER President, Deutsche Bundesbank Silvio Berlusconi Guilio Tremonti
Italy
Nicholas C Garganas EL Governor, Bank of Greece Prime Minister Minister of Economy & Finance
Jean-Claude Juncker Jean-Claude Juncker
John Hurley IR Governor, Central Bank of Ireland Luxembourg
Prime Minister & Minister of Finance Prime Minister & Minister of Finance
Antonio Fazio IT Governor, Banca dItalia Jan-Peter Balkenade Johannes Hoogervorst
Netherlands
Yves Mersch L Governor, Banque centrale du Luxembourg Prime Minister Minister of Finance
Nout Wellink NL President, De Nederlandsche Bank Jos Manuel Duro Barroso Maria Manuela Dias Ferreira Leite
Portugal
Vitor Manuel Ribeiro Constncio PT Governor, Banco de Portugal
Jose Marie Aznar Rodrigo Rato
Spain
Jaime Caruna ES Governor, Banco de Espaa Prime Minister Minister of the Economy
The European Commission

Romano Prodi (IT) Frits Bolkestien (NL) Franz Fischler (A) Poul Nielson (DK) Pedro Solbes Mira (ES)
President of the European Commission Internal Market, Taxation & Customs Union Agriculture, Rural Development & Fisheries Development & Humanitarian Aid Economic & Monetary Affairs
Neil Kinnock (UK) Phillippe Busquin (B) Pascal Lamy (FR) Chris Pattern (UK) Gnter Verheugen (GER)
Vice President Administrative Reform Research Trade External Relations Enlargement
Loyala de Palacio (ES) David Byrne (IRL) Erkki Liikanen (FIN) Viviane Reding (L) Antonio Vitorino (PT)
Vice President Energy & Transport Health and Consumer Protection Enterprise & Information Society Education & Culture Justice & Home Affairs
Michel Barnier (FR) Anna Diamantopoulou (GR) Mario Monti (IT) Michaele Schreyer (GER) Margot Wallstrm (S)
Regional Policy Employment & Social Affairs Competition Budget Environment
Source: UBS Warburg

Euro Area Data Decoder March 2003 A CHRONOLOGY OF EMU
Appendix 2: A Chronology of EMU

1948 to 1970
1948 16 April The Organisation for European Economic Cooperation (OEEC) a forerunner of the OECD is
created to oversee the Marshall Plan for the reconstruction of Europe
1950 9 May The Schumann Declaration Robert Schumann - French Foreign Minister - proposes that France and Germany and any other
European country wishing to join them pool their Coal and Steel resources
1951 18 April Treaty of Paris Six countries, Germany, France, Belgium, Luxembourg, the Netherlands and Italy (The Six), sign
the Treaty of Paris which establishes the European Coal and Steel Community (ECSC). The
Treaty made provision for a High Authority, a special Council (of Ministers) a European
Assembly and a European Court of Justice. The Treaty enters into force on 25 July 1952.
1953 10 February The Common Market for coal and iron ore is put in place. The Six remove customs duties and
quantitative restrictions on these raw materials. The common market for scrap iron follows on 15
March.
1957 25 March Treaties of Rome The Six sign the Treaties which establish the European Economic Community (EEC) and
European Atomic Energy Community (Euratom) to work alongside the ECSC. The Treaty
creating the EEC establishes the goal of creating a common market, as well as the principles
relating to the free movement of goods, labour and capital.
1958 1 January The Treaties of Rome enter force. The EEC and Euratom are based in Brussels. The
Parliamentary Assembly (Luxembourg) and the Court of Justice are common to the ECSC, EEC
and Euratom
3-11 July A meeting at Stressa (Italy) agrees the basis for a common agricultural policy (CAP)
1960 4 January Stockholm Convention Seven countries (Austria, Denmark, Norway, Portugal, Sweden, Switzerland and the United
Kingdom) agree to establish the European Free Trade Association (EFTA). The Convention
enters into force on 3 May.
11 May The Council create the European Social Fund (ESF) to promote employment and professional
and geographic mobility of workers with the Community
14 December The Organisation for European Economic Cooperation (OEEC) becomes the Organisation for
Economic Cooperation and Development (OECD).
1962 27-30 March The Parliamentary Assembly changes its name to the European Parliament
1963 14 January Accession negotiations with four countries (the UK, Ireland, Denmark and Norway) fail. These
countries reapply for membership in 1967.
1965 8 April The Merger Treaty A Treaty fusing the Executives of the three Communities (EEC, ECSC, Euratom) to provide a
single Council and a single Commission is signed in Brussels. The Treaty comes into force on 1
July 1967
1968 1 July Customs Union completed The remaining customs duties in intra-Community trade are abolished. The Common Customs
Tarriff replaces national customs duties in trade with the rest of the world
1969 1-2 December Barre Plan At a Summit meeting in the Hague, The Six agree to make full economic and monetary union
an official goal along the lines of the Barre Plan. In March 1970, the Council appoints Pierre
Werner to lead a committee of experts to devise a detailed plan for achieving economic and
monetary union.
1970 30 June Negotiations are opened with four prospective Member States (Denmark, Ireland, Norway and
the United Kingdom)
117 UBS Warburg

Chronology contd (1971 to June 1989)

1971 22 March Werner Plan adopted The Council adopts the Werner Plan to strengthen economic co-operation. The Plan envisages
harmonisation of budgetary policies and limiting currency fluctuations. It also envisages a stage
by stage attainment of economic and monetary union by 1980
15 August US suspends convertibility of USD to gold. USD moves to a floating regime
1972 22 January Treaties of Accession The UK, Ireland, Denmark and Norway sign accession Treaties
24 April Currency "Snake" established The Six agree to limit the margin of fluctuation between their currencies to 2.25%. The
experiment in currency control was largely abandoned within 2 years. Currencies return to a
free float in March 1973
25 September Norwegian Referendum Majority vote against Norwegian membership of the European Communities
1973 1 January 1st Enlargement Denmark, Ireland and the United Kingdom join the European Communities. A Free Trade
Agreement with Austria, Switzerland, Portugal and Sweden enters into force.
1976 27 July Negotiations for Greek accession are formally opened
1977 1 July Common Customs Tariff is extended to include the UK, Ireland and Denmark
1978 6 June Negotiations for Portuguese accession are formally opened
4-5 December European Monetary System European Monetary System (EMS) established with the objective of creating a zone of
monetary stability. The Exchange Rate Mechanism (ERM) of the EMS requires Member States
to limit the fluctuations in their currencies against the European Currency Unit (ECU) to 2.25%.
The EMS comes into force on 13 March 1979. The UK does not join the ERM. The Italian lire
has fluctuation bands of +/-6%.
1979 5 February Negotiations for Spanish accession are formally opened
1981 1 January 2 Enlargement

nd Greece becomes the 10th member or the European Community
1984 September ECU basket is adjusted to accommodate the Greek drachma
1985 1 February Greenland leaves the Community
12 June Accession Treaties for Spain and Portugal are signed
1986 1 January 3 enlargement

rd Spain and Portugal become the 11th and 12th members of the European Community
17 & 28 February Single European Act The Single European Act modifying the Treaty of Rome is signed. The Act sets a deadline for
completing the internal market of 31 December 1992. The Act introduces Qualified Majority
Voting (QMV). The Act enters into force on 1 July 1987.
1988 June The European Council confirms the objective of progressive realisation of economic union and
mandates a committee chaired by Jacques Delors, then President of the European
Commission, to study and propose concrete stages leading to this union. The result is the
Delors Report
1989 12 April Delors Report The Delores Report on achieving economic and monetary union is published. It proposes EMU
be achieved in three discrete but evolutionary steps
June The European Council decides that the first stage of the realisation of economic and monetary
union should begin on 1 July 1990 the date on which, in principle, all restrictions on the
movement of capital between member states were abolished.
19 June The Spanish peseta joins the Exchange Rate Mechanism (ERM) with a +/- 6% band. The ECU
is adjusted to incorporate the Spanish peseta and the Portuguese escudo
118 UBS Warburg

Chronology contd (June 1989 to 1995)

1989 9 November The Berlin Wall collapses
1990 29 May The agreement establishing the European bank for Reconstruction and Development (EBRD) to
provide financial support for Central and Eastern Europe is signed in Paris. The EBRD is
inaugurated in London on 14 April 1991.
19 June Schengen Agreement The Schengen agreement on the elimination of border checks is signed by Germany, France,
Belgium, the Netherlands and Luxembourg. Italy signs in November. Austria, Finland and
Sweden sign in December 1996.
1 July 1st stage of EMU begins. The objectives are to foster greater economic convergence, remove
obstacles to free capital movement and avoid exchange rate realignments.
3 October German unification
8 October Sterling joins the ERM with +/- 6% bands
1991 21 October The Council agrees the establishment of the European Economic Area (EEA) creating a free
trade area and extending co-operation between the EEC and EFTA
1992 7 February The Treaty on the European Union The Treaty on the European Union (TEU) is signed in Maastricht. The Maastricht Treaty sets
out the timetable and three stages for achievement of Economic and Monetary Union (EMU).
The Treaty enters into force on 1 November 1993
4 April The Portuguese escudo enters the ERM
2 May An agreement on European Economic Area (EEA) extending co-operation between the EEC
and EFTA is signed in Porto. It enters into force on 1 January 1994.
2 June Danish Referendum The Danes vote against the ratification of the Treaty on the European Union
September Sterling and the Italy leave the ERM. Spanish peseta and Portuguese escudo are devalued
within the ERM
1993 1 January The Single European Market enters into force
January Irish pound is devalued within ERM
1 February Negotiations on accession for Austria, Finland and Sweden are opened
5 April Negotiations on the accession of Norway open
18 May In a second referendum Denmark votes in favour of the Treaty on European Union
May Spanish peseta and Portuguese escudo are devalued within the ERM
2 August ERM fluctuation bands are widened to +/- 15%
1994 1 January Stage II of EMU begins. The objectives are the removal of any remaining capital controls,
further exchange rate stability and the selection of Members for Stage III. The European
Monetary Institute (EMI) is formed. Its role is to strengthen central bank co-operation, make
preparations required for the establishment of the ESCB, the conduct of monetary policy and
the creation of a single currency in Stage III.
24-25 June Acts of Accession for Austria, Sweden, Finland and Norway are signed
28 November Norwegian referendum Norwegians vote against membership of the European Union
1995 1 January 4th Enlargement Sweden, Finland and Austria become members of the European Union
December The European Council agrees to call the European currency unit to be adopted at the start of
Stage III, the euro. 1 January 1999 is confirmed as the start date for Stage III
119 UBS Warburg

Chronology contd (1996 to 2001)

1996 14 October The Finnish Mark joins the ERM
25 November The Italian lire re-enters the ERM
13-14 December The European Council in Dublin reaches agreement on the legal framework, Stability Pact and
ERMII required for the introduction of the single currency
1997 June The European Council adopts the Stability and Growth Pact two regulations form part of the
Stability and Growth Pact, which aims to ensure budgetary discipline in respect of EMU. The
Pact was supplemented and the respective commitments enhanced by a Declaration of the
Council in May 1998.
2 October Amsterdam Treaty The Amsterdam Treaty is signed. The Treaty aims to make the Unions institutional structure
more efficient thereby opening the way for further enlargement. The Treaty enters into force on
1 May 1999.
1998 16 March The Greek drachma enters the ERM
3 May A special Council decides, based on an earlier European Commission report, that 11 Member
States fulfil the conditions for the adoption of the single currency on 1 January 1999. These
member states are Austria, Belgium, Finland, France, Germany, Italy, Ireland, Luxembourg, the
Netherlands, Portugal and Spain. The remaining EU15 members, Greece, Denmark, the UK
and Sweden are the outs. The Commission and the EMI set out the conditions for the
irrevocable conversion rates for the euro
26 May The Governments of the 11 Member States adopting the euro appoint the President, Vice-
President and Executive Board of the European Central Bank (ECB)
1 June The European Central Bank (ECB) formally begins its operations, replacing the EMI. The ECB
and the national central banks of the participating member states constitute the Eurosystem,
which formulates and defines the single monetary policy in Stage III of EMU.
1999 1 January The euro is officially launched. 11 Member States adopt the euro.
15 March The European Commission collectively resigns over allegations of fraud, mismanagement and
nepotism
15 September The European Parliament votes and approves the appointment of the new Commission
2000 15 January The opening session of the IGC for the accession negotiations of Malta, Romania< Slovakia,
Latvia, Lithuania, and Bulgaria is held in Brussels
14 February The IGC on institutional reform opens in Brussels
3 May The Commission proposes Greece as the 12th member of the euro area
22 September The ECB, acting together with the US Federal Reserve and the Bank of Japan, intervenes in
currency markets to support the euro
28 September Danish referendum A referendum in Denmark rejects membership of the single currency
2001 2 January 1st enlargement of the euro area Greece becomes the 12th member of the euro area
26 February Treaty of Nice Treaty of Nice is signed. The Treaty brings changes to the size and composition of the
Commission, the weighting of votes in the Council, the increased use of qualified majority voting
and reinforces closer cooperation among Member States
7 June Irish Referendum The Irish people vote against ratification of the Treaty of Nice
14 December Euro starter kits are distributed to help the public prepare for the currency changeover
120 UBS Warburg

Chronology contd (2002...)

2002 1 January The euro notes and coin enter circulation
28 February The period dual currency circulation comes to an end. The euro becomes the sole currency for
the 12 Member States. The opening session of the Convention on the Future of Europe is held
in Brussels
9 October The Commission considers that Cyprus, the Czech republic, Estonia, Hungary, Latvia,
Lithuania, Malta, Poland, the Slovak Republic and Slovenia will be ready for membership of the
European Union from the beginning of 2004.
19 October Irish Referendum In a second referendum Ireland votes in favour of he Treaty of Nice.
12-13 December The Council in Copenhagen finalises accession negotiations with Cyprus, the Czech Republic,
Estonia, Hungary, Latvia, Lithuania Malta, Poland the Slovak Republic and Slovenia and sets
an accession date of 1 May 2004
121 UBS Warburg

Appendix 3: Useful Websites
122 UBS Warburg

European organisations International organisations
Eurostat http://europa.eu.int/comm/eurostat/ Organisation for Economic Co-operation & Development http://www.oecd.org/
European Central Bank http://www.ecb.int/ International Monetary Fund http://www.imf.org/
European Commission http://europa.eu.int/comm/ Bank for International Settlements http://www.bis.org/
- Directorate General for Economic & Financial Affairs http://europa.eu.int/comm/economy_finance/ European Bank for Reconstruction and Development http://www.ebrd.com/
European Council http://ue.eu.int/ World Bank http://www.worldbank.org/
European Parliament http://www.europarl.eu.int/ World Trade Organisation http://www.wto.org/
Source: UBS Warburg
Source: UBS Warburg
National organisations
Euro area members Statistical Offices Central Banks Economic and Finance Ministries
Austria http://www.statistik.at/ http://www.oenb.co.at/ http://www.bmf.gv.at/
Belgium http://statbel.fgov.be/ http://www.bnb.be/ http://www.treasury.fgov.be/
Finland http://www.stat.fi/ http:///www.bof.fi/ http://www.vm.fi/
France http://www.insee.fr/ http://www.banque-france.fr/ http://www.finances.gouv.fr/
Germany http://www.destatis.de/ http://www.bundesbank.de/ http://www.bundesfinanzministerium.de/
Greece http://www.statistics.gr/ http://www.bankofgreece.gr/ http://www.mof-glk.gr/
Ireland http://www.cso.ie/ http://www.centralbank.ie/ http://www.finance.gov.ie/
Italy http://www.istat.it/ http://www.bancaditalia.it/ http://www.tesoro.it/
Luxembourg http://statec.gouvernement.lu/ http://www.bcl.lu/ http://www.etat.lu/FI/
Netherlands http://www.cbs.nl/ http://www.dnb.nl/ http://www.minfin.nl/
Portugal http://www.ine.pt/ http://www.bportugal.pt/ http://www.min-financas.pt/
Spain http://www.ine.es/ http://www.bde.es/ http://www.mineco.es/
Other countries
Denmark http://www.dst.dk/ http://www.nationalbanken.dk/ http://www.fm.dk/
Japan http://www.stat.go.jp/ http://www.boj.or.jp/ http://www.mof.go.jp/
Norway http://www.ssb.no/english/ http://www.norges-bank.no/ http://www.odin.dep.no/fin/
Sweden http://www.scb.se/ http://www.riksbank.se/ http://www.finans.regeringen.se/
Switzerland http://www.statistik.admin.ch/ http://www.snb.ch/ http://www.dff.admin.ch/
UK http://www.statistics.gov.uk/ http://www.bankofengland.co.uk/ http://www.hm-treasury.gov.uk/
US http://www.fedstats.gov/ http://www.federalreserve.gov/ http://www.ustreas.gov/
Source: UBS Warburg

Global Economic Analysts

George Magnus +44-20-7568 3322 george.magnus@ubsw.com Chief Economist
Global Economics
Paul Donovan +44-20-7568 3372 paul.donovan@ubsw.com Senior Economist
Andrew Cates +44-20-7568 6892 andrew.cates@ubsw.com Senior Economist
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US
Maury Harris +1-203-719 7301 maury.harris@ubsw.com Chief Economist Americas
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Stacy Nemeroff +1-212-713 2961 stacy.nemeroff@ubsw.com Economist
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Europe
Kevin Gaynor +44-20-7568 1915 kevin.gaynor@ubsw.com Europe
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Fixed Income Strategy
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123 UBS Warburg

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Europe Economics March 2003

A guide to the euro area macroeconomic

Chapter 5: Industrial Production................................................................... 63

The organisation of the document is as follows. In Section 1 we provide a run

Section 1: The euro area policy framework

Chapter 1: Monetary Policy

To provide a forum for discussion of monetary policy issues affecting all EU

Voting in the Governing Council: today and after EMU enlargement

Chart 1: The structure of the European System of Central Banks (ESCB)

European Central Bank (ECB)

European System of Central Banks (ESCB)

Nationale Bank van Belgi/

Deutsche Bundesbank Banque centrale du Luxembourg

Bank of Greece De Nederlandsche Bank

Banco de Espaa Oesterreichische Nationalbank

Banque de F rance Banco de Portugal

Central Bank of Ireland Suomen Pankki

Danmarks Nationalbank Sveriges Riksbank

The ranking mechanism

Assigning voting rights - the proceedure

Group 3 Three votes shared between the remaining NCB governors

Source: ECB, UBS Warburg

Policy goals and independence

...Defined as 0-2% inflation The ECB defines price stability as follows:

The ECBs independence is Article 108 of the Treaty states that:

The ECBs policy strategy

Chart 2: The ECBs monetary policy strategy

Pr im ary ob je ctiv e of p ric e s ta bility

G ove rn in g Cou ncil

How much money? Deriving the M3 reference value

Chart 3: M3 growth and the ECBs refi rate

Source: ECB, Datastream, UBS Warburg

Policy instruments: the operational framework

Table 1: Eurosystem open market operations and standing facilities

Monetary policy Types of transactions Maturity Frequency Procedure

Fine-tuning Reverse transactions Foreign exchange Non-standardised Non-regular Quick tenders

Deposit facility Deposits Overnight Access at the discretion of counter-parties

Chart 4: ECB and overnight money market rates

Marginal refi rate

Source: Datastream, UBS Warburg

Table 2: ECB rate changes in the first three years of EMU

With effect Deposit Main refinancing operations Marginally

Transparency and communication

Evaluation: is the ECB behind the curve?

Chart 5: ECB policy rates and the Taylor rule

Traditional Taylor rate

Source: ECB, UBS Warburg;

Another tool to analyse the monetary policy stance is to consider a Monetary

Source: Datastream, UBS Warburg

The unresolved issue: one size does not fit all

Source: UBS Warburg

Chapter 2: Fiscal Policy

The Stability and Growth Pact

The SGP: Learning by doing

Following the surprising disappointments in the Portuguese, Greek and German

Euro Area Data Decoder March 2003

Blank space here Blank space here

10m Yes Compliance No Decision on sanctions

Council Council Progress in correcting Abrogation of sanctions

Blank space here Blank space here

The European Commissions proposals

2) Establish transitional arrangements for countries with underlying deficits

4) Ensure public finances contribute to growth and employment. Member states

5. Make the sustainability of public finances a core policy objective. This