DP472 European Monetary Union or Hard EMS?

Author(s): David Currie, Paul L Levine, Joseph Pearlman
Publication Date: October 1990
Keyword(s): Credibility, European Monetary System, Inflation, Monetary Union
JEL(s): 431, 432
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=472

This paper contributes to the debate engendered by the Delors Report on the issue of European Monetary Union. It focuses on the options of a strengthened (or hard-) EMS, with a commitment to a fixed exchange rate relative to the Deutschmark, or a European central bank with full monetary union (EMU). Under hard-EMS, an anti-inflationary reputation is acquired by all as a result of Bundesbank credibility. As regards EMU, it is possible that too rapid a move through the latter stages of the Delors process will produce a central bank with little or no anti-inflation credibility. Here we make starkest assumption of no credibility under EMU, and compare it with hard-EMS for various supply and demand shocks using a two-bloc model, the latter exhibiting short-run wage/price stickiness but with long run natural rate properties. A non-EMS regime with floating exchange rates is used to examine the incentive compatibility of hard-EMS and EMU, with a cooperative reputational regime acting as a benchmark.