The authors argue that:

 

• Conducting a European monetary policy is very different than living under the protective umbrella of the Bundesbank. They discuss voting on the ECB board, and argue that the ability to communicate to the public will be a critical factor for the success of the new institution.

 

• How a single monetary policy – a common change in the interest rate controlled by the ECB – is transmitted differs significantly to the economy of member countries.

 

• Initially at least, the cost of a disinflation episode could fall very unequally on a few member countries; those with both a financial structure that spreads a monetary contraction very widely and a wage-price structure that is relatively inflexible. Moreover this process is sure to evolve, in part as a result of the financial industry restructuring that is already underway, but will be accentuated by the common money.

After EMU is launched on 1 January 1999, all members will share a common short-term interest rate. Some economists warn that a single monetary policy may be unwise if growth rates and hence inflationary pressures differ across Europe. For example, last year Ireland’s economy grew by 10% while Germany’s only grew by 2.5%. This suggests that Ireland needs higher interest rates than Germany. But even if all countries were at the same point in the economic cycle, Europe’s central bank would still have a problem. Differences in the way interest rates affect output across Europe mean that a given rise in rates would depress some economies more than others.

In conducting monetary policy, the new ECB will face three major issues all connected to the fact that the bank will conduct a ‘European’ monetary policy, which nobody has ever done before. Conducting a European monetary policy involves three challenges.

• First, the ECB must tread the narrow path between an institutional revolution and uninterrupted continuity with the Buba. The capital markets will be unforgiving if they see anything less than Bubaness. But the political community will be unforgiving if they do not see a genuine preoccupation with being European – creating a language and constituency that goes beyond German savers and monetary hawks. The legitimacy which the ECB must build depends critically on its understanding that its constitution in no way guarantees its political effectiveness. The success relies critically on developing successful communication.

 

• Second, the ECB must conduct a European policy. It cannot allow itself to solve every local problem by excessive regionalization of its policy; it must work on the broad picture of stabilizing European prices, not putting a lid on German inflation or a floor under French deflation. The challenge is to shift the discussion to European averages and credibly work with these.

 

• Third, the ECB has to develop a grip of the monetary mechanism in the European economy. That task is complicated because financial structures and wage-price processes differ widely. The authors demonstrate that the monetary process differs significantly across countries. Moreover, that process is sure to evolve in part as a result of the financial industry restructuring that is already underway and is accentuated by the common money. Furthermore, as the ‘Lucas critique’ suggests, the wage-price process itself will adapt to the changing focus of European monetary policy. Shooting at a moving target in the fog is no easy task.

EMU: Prospects and Challenges for the Euro is a special issue of the review, Economic Policy: A European Forum. It contains revised versions of the papers presented to the Twenty-Sixth Economic Policy Panel Meeting held in Bonn on 17/18 October 1997, with the support of the Zentrum für Europäische Integrations-forschung. The Economic Policy Panel meets twice annually to discuss papers that are specially commissioned by the editors to provide timely and authoritative analyses of the choices confronting policy-makers. The articles use the best of modern economic analysis, but are easily accessible to a wide audience and highly readable. Each paper is discussed by a rotating Panel of distinguished economists whose comments are published to provide the reader with alternative interpretations of the evidence and a sense of the liveliness of the current debate.

Economic Policy is published in association with the European Economic Association for the Centre for Economic Policy Research, the Center for Economic Studies of the University of Munich and the Département et Laboratoire d’Economie Théorique et Appliquée (DELTA), in collaboration with the Maison des Sciences de l’Homme.

Rudi Dornbusch is Ford Professor of Economics and International Management at the Massachusetts Institute of Technology. He is also a Research Fellow in CEPR’s International Macroeconomics and International Trade programmes. Carlo Favero is based at Innocenzo Gasperini Institute of Economic Research (IGIER) at Università Bocconi and is a Research Fellow in CEPR’s International Macroeconomics programme and Francesco Giavazzi is Professor of Economics at Università Bocconi, where he founded the Innocenzo Gasperini Institute of Economic Research (IGIER). He is also a co-Programme Director of CEPR’s International Macroeconomics programme.

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