Eddie George, Governor of the Bank of England, outlines an
economic, rather than political, approach to the challenges of monetary
union
The single monetary policy would anyway be beyond the reach
of national governments if they were tempted to seek a short-run increase
in output at the expense of higher inflation. And the Maastricht Treaty
logically imposes continuing constraints on excessive overall fiscal deficits,
although within those constraints overall fiscal policy, as well as decisions
on taxation and expenditure separately, are matters for national governments.
Given this, and given that monetary union removes the safety valve of exchange
rate realignment within Europe so that this escape route would no longer
be available, persistent relative inflationary pressures in one part of
the monetary union would tend to be punished by falling economic activity
and rising unemployment. That realisation ought to make inflationary price
or wage behaviour in the private sector too less likely than hitherto.
.
Steps
towards monetary union should be debated on their economic merits, and the
economic issues should not be lost sight of in the heat of the broader political
debate. If we ask why we should be contemplating a move to monetary union,
the economic - as distinct from the possibly political - answer would have
to be that the permanent elimination of exchange rate fluctuations between
the member states would promote economic prosperity within Europe by increasing
further the benefits to be derived from the single European market. But
there are equally economic risks in seeking to go too far or too fast.
But let me first define more precisely what I mean by monetary union
in this context. Most people think immediately of monetary union and a single
currency in terms of the replacement of their familiar bank notes and coinage
by common European bank notes and coins. This is understandable, but it
seems to me unfortunate because, like so many aspects of the European debate,
it immediately arouses political and popular sensitivities that tend to
obscure the more fundamental economic issues. The practicalities certainly
need to be properly explored, but it is important that the debate about
monetary union should not become bogged down in the technicalities of a
single currency at the expense of the more fundamental issue of whether
irrevocably to fix exchange rates in the first place. It would be a classic
case of the tail wagging the dog!
What then are the potential benefits and the possible risks of monetary
union in this more fundamental sense? I would not question the view that
sustained monetary and exchange rate stability within the European Union
is wholly desirable and would substantially increase the benefits of the
single market by improving the efficiency of resource allocation within
Europe. Monetary stability is desirable in itself - whether regionally or
nationally - as a necessary condition for sustainable growth and to reduce
the risks of long-term investment. And it contributes to real exchange rate
stability, encouraging investment to be located where, within the European
Union, it is most productive.
How far monetary union would contribute to this is a matter of degree.
Countries individually have a strong national interest in pursuing monetary
stability quite independently of the European dimension. I doubt whether
we could be contemplating monetary union at all if it were not for the strength
of the consensus that has emerged over the past decade or more - within
Europe but also much more widely - on the crucial importance of monetary
stability to economic prosperity. And if we were all individually successful
in pursuing domestic monetary stability then that would help to produce
some measure of exchange rate stability. In other words, some of the undoubted
advantage of monetary and exchange rate stability could be achieved, in
principle, without formal monetary union.
The economic argument for monetary union is that it would deliver greater
EU-wide stability in practice and, importantly, that it would carry greater
conviction with investors that intra-European stability would be maintained
into the medium and longer term. Given past experience of both domestic and exchange rate instability
within the countries of Europe, I am inclined to agree that there is substance
in this.
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Even so, monetary stability within Europe would not be guaranteed. It
would depend upon how successfully the independent European central bank
pursued its mandate to maintain price stability within the monetary union
as a whole. But there is no reason to suppose that it would be less successful
than European countries generally have been in the past in pursuing price
stability through independent national policies - rather the reverse.
Some people argue that even if, as a matter of degree, monetary union
did make for greater monetary stability within Europe than would otherwise
be achieved, national acceptance of such a strong external discipline would
be a high price to pay. That, of course, is intrinsically a political judgement.
But it would be a mistake to imagine that the discipline of monetary stability
could be avoided without monetary union. If anything, that discipline would
be more important for countries that did not participate because they would
have to demonstrate that remaining outside monetary union was not simply
seen as a soft option. Otherwise they would be likely to suffer in terms
of both financial and physical investment, and their economies would remain
vulnerable to disruptive intra-European capital flows.
While European monetary stability can in principle be achieved without
monetary union, and while this could deliver de facto relative exchange
rate stability, this would not provide the business community with certainty
about intra-European exchange rates over the medium and long term. That
would be a unique advantage of monetary union. Options nevertheless differ
on just how great an advantage it would be, given that market mechanisms
for eliminating the exchange risks are available - at a price.
Similarly monetary union - even without a single currency - would yield
some benefits in terms of intra-area transaction costs. But while this is
undoubtedly a factor on the plus side it is certainly not significant enough
on its own to be decisive.
What then is the economic case on the other side?
Essentially, the argument is that there are, and could continue to be,
significant economic differences between the member countries of the EU
that could cause tensions between them that would be difficult to relieve
without the continuing possibility of exchange rate adjustment between the
member currencies. In that case, in monetary union the monetary policy appropriate
in some countries would be inappropriate in others, leaving the European
central bank in a dilemma as to what (single) monetary policy to pursue.
People point to the problems that arose within the ERM as a result of
the economic 'shock' of German reunification as an example of the sort of
tensions that could arise. It is certainly true that that did produce a
situation in which the appropriate monetary policy in Germany was excessively
tight for the conditions prevailing elsewhere in Europe - and while the
circumstances in that case were, of course, quite exceptional, it is possible
to envisage other shocks which could have similar assymetrical effects.
The possibility of inadequate convergence is explicitly recognised in
the Maastricht Treaty, which lays down more or less precise criteria designed
to ensure that conjectural convergence, at least, is achieved before any
move to the irrevocable locking of exchange rates. Those criteria relate
to relative rates of inflation, to exchange rate stability, and to relative
long-term interest rates - all observed over a qualifying period - as well
as to fiscal deficits and public debt ratios. The Treaty also contains ongoing
provisions to prevent the subsequent emergence of excessive national fiscal
deficits.
There is a concern that the Maastricht convergence criteria
are not in themselves sufficient. The worry is that it may be possible for
a country to meet the Maastricht criteria - which relate to nominal values
- at a particular point in time but with no assurance that such convergence
could be sustained into the medium and longer term. What matters fundamentally
for the successful functioning of monetary union is that economic convergence
is capable of being sustained. We should be confident that convergence is
real and that it is sustainable before moving forward. It is in no one's
interests for that decision to be fudged.
If it were to be fudged, the costs could be substantial. The European
central bank is, quite rightly, required by its statute to set the single
monetary policy so as to maintain price stability in the monetary union
as a whole. In that case, and if inadequate sustainable convergence were
not to result in long-term stagnation and unemployment in some parts of
the union, there are only two possible adjustment mechanisms - neither of
which on present evidence looks likely to be particularly effective.
First, there is the possibility of migration from areas of high unemployment
to areas of lower unemployment. Secondly, there could be pressure for larger
fiscal transfers from countries with lower unemployment to countries where
unemployment was higher.
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Neither of these possibilities
is particularly attractive. Either long-term stagnation in some countries
or the rapid expansion of these adjustment mechanisms could become a source
of political as well as economic disharmony within Europe, rather than monetary
union acting as something that brings us closer together.
I have no doubt at all that the single market brings huge economic benefits
to Europe as a whole and to its individual member states. There may be advantages
in extending it into other policy areas - though proposals in this sense
need to be examined very carefully on their economic merits and not pursued
simply for their own sake. The same applies to monetary union. There are
potential economic advantages in monetary union to the extent that it would
increase economic and monetary stability in Europe and make the single market
more effective. But there are also potential economic risks in moving ahead
before sustainable convergence is assured. It would be an enormous step.
A decision to take that step is, quite rightly of course, a decision that
has to be taken through the political process. But it must be in the interests
of the EU as a whole that that decision is informed by a careful and dispassionate
assessment of the economic arguments.
It is not a decision that can or should be taken now. We all have our
work cut out to achieve economic and monetary stability, and to address
the problem of structural employment in Europe, through our independent
national efforts and through European co-operation. And we have a great
deal still to do in continuing to explore both the economic and technical
conditions that would need to be met before any decision could be made.
The important thing is that we all carry forward this work patiently and
with an open mind.
This article is an edited extract of a speech delivered by Eddie George
at the Fondation J P Pescatore, Luxembourg, in February 1995.
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©Kensington Publications 1996