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European
Economic Perspectives 1
October 1993
Til
EMS Do You Part
Co-operation
among governments can withstand only so much pressure.
It
is easy for friends to get along in good times. In difficult times,
magnanimity may become an unaffordable luxury. The fate of the ERM can
be analysed largely in these simple terms.
After
the recession of the early 1980s, falling inflation and relatively
steady growth helped to consolidate the European Monetary System. But
the slowdown of the 1990s brought rising unemployment and expanding
budget deficits to much of the EC. German unification led to higher
interest rates both in Germany and, because of the ERM, elsewhere in the
community. Suddenly countries had to cope not only with different
shocks, but also with different domestic priorities. Stability and the
consensus which the ERM had been based upon (and had helped to create)
were gone.
Partners
can deal with conflicting goals in two ways. They can agree in advance
in a social-choice mechanism to resolve such conflicts. Or they can
agree in advance that when conflicts arise they will go their own way.
For the EC, the first solution requires further steps towards political
union. The second requires a return to floating exchange rates. The EMS
countries chose an intermediate path: they aimed to create a system of
fixed exchange rates (with liberalised financial markets) without moving
quickly toward closer monetary and political union. In good times, this
strategy was the easiest political choice. In bad times it proved to be
unsustainable.
In
the first decade of the EMS the main concern of the members was to
defeat inflation. By linking themselves to Germany and delegating the
conduct of monetary policy to the Bundesbank, the other members felt
that they would be strengthened in that task. Most EC governments lacked
credibility on the conduct of monetary policy. Germany was willing to
provide it. But once inflation was beaten the other concerns became more
pressing. At this point, the lack of any agreed-upon mechanism for
resolving differences over policy - except for that of merely accepting
German leadership - became harder to tolerate. When unification
confronted Germany with a very large and idiosyncratic shock, this
difficulty was greatly aggravated. Soon it was plain (at least to the
financial markets) that it was no longer desirable for the ERM members
to delegate policy-making to the Bundesbank.
The
EC countries should now understand what their real choices are:
political union or floating rates. Both choices have their drawbacks.
Political union would require substantial redistributions of income from
rich countries to poor; such policies cause friction even within
countries (witness Belgium, Italy and Spain), let alone among them.
Floating exchange rates on the other hand, would threaten Europe's
single market for good and services, the EC's greatest achievement.
Nonetheless this difficult choice will have to be made. In either case,
the Maastricht timetable - indeed, its whole approach to European
Integration - should be abandoned. Now is the time for frank talk, not
more false starts and failures.
Frank
talk should also make clear whether Europe is heading toward a one-speed
or multi-speed monetary union. The multi-speed solution is politically
more feasible (as Jürgen von Hagen suggests above). It is unclear,
however, whether the fast-track group will ever admit the rest. If the
fast-track countries find that their restricted monetary union is a
success, they may decide it is not in their interest to enlarge it. New
members would alter the political equilibrium established within the
first group. A Europe divided in this way would defeat the purpose of
the EC's founders and pose new threats of instability. To avoid this,
objective criteria for new entry need to be established in advance.
The
EC is now at a crucial juncture. The ERM crisis is seen by many as proof
that European union is neither inevitable nor painlessly achievable. The
community's leaders must think again about the role of the nation-state
within Europe, and decide to what extent, if at all, national
sovereignty will be relinquished in favour of a federal authority.
Alberto
Alesina and Vittorio Grilli
Alesina
is a Professor of Economics at Harvard University: Grilli is a Professor
of Economics at Birkbeck College, London, and is currently a senior
advisor to the Italian Treasury Ministy.
Both are research fellows in CEPR's International Macroeconomics
programme.
The views expressed by the authors are their own, not those of the
Italian Treasury Ministry.
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