OP:12 European Monetary Policy in Stage Three: What are the Issues?
Author(s): Carlo Monticelli and José Viñals
Publication Date: January 1993

Abstract: According to the Treaty on European Union, the European System of Central Banks (ESCB) will decide and implement the single monetary policy in the Union. Monetary sovereignty has traditionally been an important symbol of national identity and thus relinquishing it constitutes an event of historical significance. Furthermore, the Treaty rules out any gradual transfers of monetary powers towards the central institutions during the transition and thus the start of Stage Three will be a sort of 'Big Bang', with a sudden shift from the coexistence of national monetary policies, formulated in the pursuit of national objectives and implemented through different procedures, to a single monetary policy, set by a supranational institution with Union-wide objectives and operated in a consistent way throughout the area.

That range of issues that must be settled to warrant that the single monetary policy can be effectively run from the very first day of Stage Three is very wide and covers a variety of aspects. As a result, the preparation of Economic and Monetary Union (EMU) is a long and complex affair extending to all fields of competence of central banks which, moreover, vary across European countries.  This is the reason why the European Monetary Institute (EMI) has been mandated to set up the regulatory and logistical framework for the future monetary policy and why certain preparations have already started within the Committee of Governors of EEC Central Banks.

Although the Statute of the ESCB provides the broad guidelines for the operation of the future monetary policy, there are a number of strategic and tactical aspects which remain open. This is also a consequence of the balance that had to be struck in the Statute between two conflicting needs. On the one hand, principles and objectives had to be stated in as unambiguous and precise a way as possible to ensure the certainty and transparency of the precepts governing the functioning of the ESCB. On the other hand, a certain degree of generality was required to avoid prejudging matters which are best solved when the precise features of the future economic and financial structure prevailing in Stage Three are known. Premature decisions would have deprived the ESCB of the flexibility necessary to achieve functional efficiency.

It would be unwise to put forward concrete proposals for the formulation and operation of monetary policy in Stage Three without knowing the outcome of the process of economic and financial integration associated with the completion of the single internal market. Some key issues can already be identified, however.

A first set of questions revolves around the credibility of the ESCB, which is essential to minimize the output costs of converging to, and then maintaining, price stability as well as to ensure that the flexibility to accommodate shocks does not fuel inflationary expectations on the part of price and wage setters. The monetary constitution embodied in the Treaty lays the foundations of credibility by setting price stability as the primary objective of monetary policy. Which is the best way to ensure that formal independence leads also to effective independence and thus to firm anti-inflationary attitude by the ESCB? Can the credibility of successful European national central banks be transferred to the new institution?

A second topic is the selection of the strategy for monetary policy, Under which conditions can intermediate targets in general, and monetary aggregates in particular, be helpful in the conduct of the future monetary policy?

A third group of concerns relates to the role of the ESCB in the conduct of policies to manage the payment system and to safeguard the stability of the financial system. Is the degree of involvement provided for by the Statute adequate? Is there a risk that some institutional arrangements may lead to difficulties in the coordination between the ESCB and other authorities?

A fourth class of issues regards the tactical aspects of the execution of monetary policy, and in particular, the objective of ensuring that the single monetary policy is run effectively and efficiently from the very first day of Stage Three. what are the minimum conditions in terms of integration of national money and capital markets in the Community and of harmonization of monetary instruments and procedures? what are the options available to execute the single monetary policy through national central banks?

Before moving to the analysis, it may be worth spelling out what this paper is not about. The discussion does not deal with the problems of transition towards EMU, nor does it address questions relating to the physical introduction of the single currency or to the implementation of other provisions of the Treaty, such as the pooling of foreign reserves or the method of allocation of seigniorage income.

The paper is organized as follows. Section 2 discusses the role played by independence and reputation in shaping the anti-inflationary credibility of the ESCB. Section 3 examines the main strategic considerations related to the role of the ESCB in the fields of monetary and financial policies. Section 4 identifies the key tactical issues in the execution of the future single monetary policy. Section 5 summarizes the conclusions.

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