European Monetary Unification
One less instrument

The EMS's success in forcing inflation rates to converge and in surviving dollar fluctuations has been attributed to the presence of exchange controls, which have allowed central banks to postpone parity realignments. With the removal of capital controls in 1992, exchange rates in Europe must become either more flexible or irrevocably fixed monetary union.
In Discussion Paper No. 298, Programme Director Francesco Giavazzi reviews the arguments for and against European monetary unification, taking into account recent developments in the analysis of exchange rate regimes. He discusses the merits of irrevocably fixed and of flexible exchange rates in highly interdependent but asymmetrical economies, where welfare losses arise from incentives to run beggar-thy-neighbour policies. A fixed rate regime also `ties the hands' of monetary authorities and, by enhancing the credibility of policy, may modify the equilibrium inflation rate. The possibility that monet ary unification may substantially reduce government revenue in highly indebted countries is, however, an important obstacle to monetary union and financial liberalization in Europe, Giavazzi argues. He discussed these issues in a lunchtime meeting, reported in this Bulletin

The Exchange-Rate Question in Europe
Francesco Giavazzi

Discussion Paper No. 298, January 1989 (IM)