DP618 From EMS to EMU

Author(s): Michele Fratianni, Jürgen von Hagen, Christopher Waller
Publication Date: January 1992
Keyword(s): Central Bank Constitution, EMI, Monetary and Exchange Rate Regimes
JEL(s): E42, E58, F42
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=618

This paper discusses the strategic choices involved in the transformation of the current EMS into a European Monetary Union. Alternative strategy proposals are evaluated under the criteria of credibility, flexibility, effective institution-building and mitigation of end games. The Delors strategy mistakes exchange rate fixity for credibility, resulting in an overly rigid and unstable strategy. The Hard Ecu provides flexibility, but is unlikely to achieve EMU. We propose a softened EMS - the Two-Tier EMS - as an alternative that meets the four criteria in a more satisfactory way. The second part develops a principal-agent model of the central bank, which embodies an explanation of political business cycles and the credibility problem. We use this model to show that the current draft of the statutes of the European Central Bank does not solve the dilemma of discretion and credibility in a satisfactory way.