European Monetary Union
Costs and benefits

Many argue that the main cost of European monetary union will be countries' loss of autonomy to alter the exchange rate in the face of asymmetric or idiosyncratic shocks. In Discussion Paper No. 722, Research Fellow Charles Bean finds that European countries are no more prone to asymmetric supply shocks than US regions, and he argues that monetary union will reduce asymmetric demand shocks. European wages are not responsive to unemployment but they do respond rapidly to price movements, so nominal inertia is relatively low and little is lost by giving up exchange rate autonomy. Countries may also benefit from the elimination of volatility and from the adoption of a credible counter-inflationary constitution; on the other hand, empirical studies have rarely found large efficiency gains from reduced volatility, and high-inflation countries could reform their institutions independently.

Bean examines the statutes of the proposed European Central Bank (ECB), which he maintains is more likely to follow discretion than a rigidly fixed rule, although Germany has little reason to fear that the ECB will be any less counter-inflationary than the Bundesbank. Also, the omission of any discussion of the supervisory role for the ECB masks profound differences across member countries, and there is no coherent justification for the proposed `convergence criteria', which risk a contractionary fiscal bias as high-debt countries strive to meet them.
Looking at interregional fiscal flows, Bean argues that comparisons with the US are inappropriate, since Europe's low labour mobility ensures a role for national fiscal policies. Interregional fiscal flows may nevertheless be desirable on insurance grounds, for which Community structural funds are too bureaucratic and susceptible to rent-seeking activities. Bean proposes a more direct, automatic and democratically accountable mechanism and concludes that such fiscal issues are much more important than those posed by the introduction of a common currency.

Economic and Monetary Union in Europe
Charles R Bean

Discussion Paper No. 722, October 1992 (IM)