European Financial Integration
Local advantage

New entrants to the EC join an economic environment itself undergoing rapid change. In Discussion Paper No. 385, Research Fellow William Branson reviews the constraints placed on macroeconomic policy by financial market integration. This is taking place in a context of large and persistent external imbalances within the EC, but the Community as a whole has an approximately balanced current account. Branson argues that intra-EC trade imbalances will be automatically financed as the financial system becomes increasingly unified.
It has been argued that, after the removal of capital controls, monetary policy will have to be devoted entirely to maintaining exchange rate parities. Branson argues that this is too drastic a conclusion when local banks have an advantage in assessing and monitoring investment prospects in their own country. National governments could maintain some independence in regulating local bank credit without jeopardizing their profitability, retaining a measure of monetary freedom. He also discusses the sequencing of reforms, arguing that simultaneous financial liberalization and EC accession may be destabilizing. It may be better for new entrants to follow the example of Spain (see Discussion Paper No. 388), embarking on domestic liberalization programmes before the advent of fully integrated European financial markets after 1993.
This paper was produced for the CEPR project on `Economic Integration in the Enlarged European Community', described more fully in Bulletin No. 36

Financial Market Integration, Macroeconomic Policy and the EMS
William H Branson

Discussion Paper No. 385, March 1990 (IM)