During 1991–3, continental Europe experienced its worst recession of the post-war period. What was the impact of monetary policies pursued within the context of EMS membership, was the policy stance taken by members an appropriate choice, and what does the experience imply for the future of monetary union? These are the questions posed by Research Fellow Paul de Grauwe in Discussion Paper No. 1047.

A monetary arrangement between nations should serve the interests of all participating members. The EMS performed this role during most of the 1980s, but not during the 1990s, when it contributed to intensification of the deflationary forces of the recession. The author argues that the EMS evolved into an asymmetric monetary arrangement in which the German Bundesbank played a dominant role in determining monetary conditions in the system. The origin of this deflationary bias lay in the lack of synchronization of the business cycles of the EMS countries, with Germany experiencing a boom while the other EMS countries were heading into a recession in 1990. Consequently, Germany's monetary targeting strategy forced EMS partners to pursue restrictive monetary policy regimes, an arrangement in which the total money stock was geared towards the exclusive objective of reducing Germany's inflation rate.

The author contends that a monetary union in which one central bank could have targeted a European money stock would have been better equipped to avoid the excessive monetary restriction of the early 1990s. Second, he draws a parallel between the present European experience and the US depression of the 1930s.

Monetary Policies in the EMS: Lessons from the Great Recession of 1991–3
Paul de Grauwe

Discussion Paper No. 1047, October 1994