European Monetary Union
After Maastricht

At a lunchtime meeting on 12 December, Alberto Giovannini discussed the outcome of the Maastricht summit and the key policy issues facing the European Community in its aftermath. Giovannini is Associate Professor of Economics and Finance at the Graduate School of Business, Columbia University, and a Research Fellow in CEPR's International Macroeconomics programme. The meeting formed part of the Centre's research programme on Financial and Monetary Integration in Europe, supported by the Commission of the European Communities under it SPES programme and by the Ford Foundation. The views expressed by Professor Giovannini were his own, however, not those of the above organizations nor of CEPR, which takes no institutional policy positions.
Giovannini noted that the widespread anxieties among proponents of monetary union before the summit that Germany was only pretending to support EMU and skilfully exploiting the convergence slogan as a delaying tactic have now been dispelled. Chancellor Kohl and his team have reiterated the convergence rules as vehemently as ever, but their commitment to EMU is total. In particular, there has been no talk of extending the option of non-participation to countries other than the UK. German de facto support largely dispels the uncertainty that has characterized the initial phase of transition, which has been reflected in market expectations, thereby weakening convergence efforts and making them much more financially onerous.
Giovannini developed an appealing theory of German behaviour and intentions: that they understood the inconsistency of tough convergence criteria and gradualism in a project of monetary union, but they also realize that the weak countries particularly Italy have to learn to replace exchange rate policies with well designed fiscal policies supported by a healthy fiscal system. To encourage this learning process, they have emphasized the tough convergence criteria, but they will be willing to be lenient when the deadline comes. Every professor likes to threaten students before an exam to induce them to work; but ex post, leniency is in everybody's best interests when the exam date comes. Similarly, the convergence criteria for monetary union have no economic justification other than as threats and incentives. Whether Italy will respond to them and pull its economy together remains unclear. The signals so far weak budgetary law, pre-election inertia and emerging political pressures for exchange rate adjustment are all negative.
Giovannini went on to outline the key condition for the successful implementation of monetary union in 1997. If a simple majority of EC member countries meet the convergence criteria during the two years preceding the 1996 summit, a qualified majority of their votes will decide whether or not to proceed. No such simple majority will be required for a second attempt at the 1988 summit, however, which will identify the countries participating in the final stage of monetary union. The members of such a union will have experienced no changes to their central exchange rate parities for two years; their interest and inflation rates will have converged; and their fiscal balances will approximate the targets laid down during the Dutch presidency, in particular the ceiling on budget deficits of 3% and the ceiling on debt/GDP ratios of 60%.
Giovannini reported that Italy stands out as a poor performer among the large countries in terms of the macroeconomic aggregates. It is conceivable that Belgium, Denmark, France, Germany, Ireland, Luxembourg and the Netherlands will meet all the criteria to allow monetary union to go ahead by 1996 and vote by simple majority to enact it in 1997. In practice, however, Italy's exclusion could make France and possibly even Germany reluctant to proceed; and any enlargement of the Community would require a bigger simple majority and complicate matters further. Giovannini concluded that the probability of an early EMU is not zero, but it is certainly not very high.
Once convergence standards and official dates for EMU have been set, it will be necessary to specify precisely how the single currency will be introduced. Giovannini explored the two main problems with the transition. First, the conversion rates from existing EC currencies into the single currency cannot possibly be in round numbers, which will present serious difficulties to the public. Second, uncertainties about such conversion rates may lead to windfall gains and losses and hence raise difficult practical and legal problems at the time the single currency is introduced.
Giovannini proposed that countries announce well in advance say in 1994 the conversion rates at which they will exchange their currencies with the ecu if and when the last stage of monetary union takes effect. This device will provide both central banks and governments with a much-needed credibility boost during the difficult transition period; it will help the public to prepare psychologically for cumbersome conversion rates; and it will enable those entering into long-term contracts to anticipate the effects of the currency reform, thus helping to minimize windfall gains and losses.