At a Brussels joint lunchtime meeting with the European Centre for Advanced Research in Economics (ECARE) on 15 July, Daniel Cohen and Jürgen von Hagen addressed strategic issues arising in the transition to European monetary union. Cohen is Professor of Economics at the Université Paris I (Panthéon-Sorbonne) and at the Ecole Normale Supérieure. He is a Research Fellow at the Centre d'Etudes Prospectives d'Economie Mathématique Appliquées à la Planification and Co-Director of CEPR's International Macroeconomics programme. Von Hagen is Professor of Economics at the Universität Mannheim and a Research Fellow in CEPR's International Macroeconomics programme. The meeting formed part of CEPR's research programme in International Macroeconomics, which is supported by the Ford Foundation. The views expressed by the speakers were their own, however, not those of the Ford Foundation nor of CEPR, which takes no institutional policy positions.

Von Hagen began by stating that the strategy for achieving EMU adopted in the Maastricht Treaty relies heavily on a tightening of the current EMS constraint as a preparation for monetary union. This approach rests on the belief that the maintenance of fixed exchange rates indicates the credibility of member governments' commitment to EMU. So long as realignments within the EMS remain possible, however, private agents will continue to take account of them in forming their inflation expectations, which in turn will cement the existing inflation differentials and increase the likelihood of such realignments over time. Tightening the exchange rate constraint also reduces the flexibility of monetary policy to react to country-specific shocks and forces policies in other regions to respond less efficiently than under full monetary union.

Von Hagen proposed overcoming these problems in the transition to EMU by speeding up the establishment of independent central banks in its member countries. Provided that these are committed to policy coordination and responsible for preparing for EMU, their independence should solve the credibility problem and allow a softening rather than a tightening of the exchange rate constraint to regain policy efficiency where necessary. Countries wanting to signal their commitment to EMU with a tight exchange rate peg to the Deutschmark could continue to do so, but only as a self-imposed constraint that imposes no obligation on the other member countries to intervene and operating within a wider exchange rate band. Such a `flexible' strategy will become more attractive if uncertainties over the ratification of the Maastricht Treaty increase.

Von Hagen noted the current widespread belief that the entry conditions specified in the Treaty will be applied rigidly; in fact the Treaty envisages a more `judgmental' procedure taking account of member countries' individual circumstances, in which the well-known convergence criteria will serve as a trigger mechanism rather than as `true' thresholds. Such an interpretation of the criteria is quite rational, given that we know so little about the precise meaning of sustainability of fiscal policies in practice.

Cohen focused on whether European monetary union will lead to a federal state and whether the US may serve as a model towards which Europe should be converging. He noted sharp differences between Europe and the US: in particular, European labour mobility is much lower, so there should be no fear, for instance, that all skilled workers will migrate to concentrate in a particular region. In the US, high labour mobility forces each state to be extremely cautious in its policy outlook, since large fluctuations could destabilize its fiscal base. In contrast, low labour mobility within Europe provides ample room for autonomous national fiscal policy. A spectacular rise in European labour mobility will be required before any resort to supranational regulation is needed or for the US model to become relevant to Europe. In such case, not only the economics, but also the politics of Europe would change dramatically; only then might the idea of a European `nation' assume greater credibility than it does today.