At a lunchtime meeting on 17 September, in the run-up to the French referendum on the Maastricht Treaty and the immediate aftermath of the first lira devaluation and sterling's suspension from the ERM, Vittorio Grilli discussed recent the prospects for European monetary union. Grilli is Woolwich Professor of Financial Economics at Birkbeck College, London, and a Research Fellow in CEPR's International Macroeconomics programme. The meeting was held to mark the launch of his book, Establishing a Central Bank: Issues in Europe and Lessons from the US, edited jointly with Matthew Canzoneri and Paul Masson and published by Cambridge University Press, the proceedings of a May 1991 CEPR joint conference with Georgetown University's Center for German and European Studies and the IMF, reported in issue 44/45 of this Bulletin. Financial support from Cambridge University Press for the lunchtime meeting is gratefully acknowledged. The views expressed by Professor Grilli were his own, however, and not those of the above organizations nor of CEPR, which takes no institutional policy positions.

Grilli noted that much recent research on EMU had focused on the effects of eliminating transactions costs and exchange rate uncertainty on investment decisions, but its greatest effects will be felt in the introduction of a common monetary policy. This will both affect the credibility of governments' anti-inflationary commitment and remove their autonomy to use monetary policy to smooth the business cycle. First, expectations play a critical role in the formulation of prices and interest rates, so a `more credible' monetary policy may enable central banks to sustain lower inflation. Grilli reported a negative correlation between national inflation rates in the OECD area and the `degree of independence' of central banks from their governments, when `independence' is measured by an index of their economic and political autonomy. In this context, `economic' autonomy consists in powers not to subscribe to the government debt and to set the interest rate, while `political' autonomy depends on factors such as the rules governing the procedures for appointing the Governor and Board members, the lengths of their tenure and the powers of government officials to influence their decisions. Under the Maastricht Treaty, the proposed European Central Bank (ECB) will be at least as independent as the Bundesbank the most independent of the EC member states' central banks today so most countries stand to gain from the enhanced commitment to low inflation entailed by monetary union.

Second, turning to the loss of national governments' monetary autonomy, Grilli noted that a monetary policy will still be used to stabilize the business cycle in the face of Community-wide shocks. Country-specific shocks may present problems, but member countries whose business cycle fluctuations are synchronous with and proportional to those of the Community as a whole will not suffer from a common stabilization policy. Grilli reported an analysis of business cycle fluctuations of the current EC member countries during 1960-90, which indicated that the French business cycle has had the closest correlation with the EC average, so France has the `least to lose' from monetary union and much to gain from the credibility of the ECB's anti-inflation commitment. Hence, if any country should vote `yes' for Maastricht, it is France. In contrast, Germany faces substantial costs from the loss of national monetary autonomy for stabilization purposes, and it has little incentive to give up the Bundesbank's well-established anti-inflation reputation.

Turning to the recent turbulence in currency markets, Grilli dismissed the common view in the aftermath of the Italian and UK devaluations that the Community should return to the `old ERM', with more frequent currency realignments. This is no longer feasible, since the capital controls that previously enabled national central banks to maintain enough control of their monetary policies to choose when to realign were abolished in July 1990. The Community must therefore choose between a free float and fixed rates. Until September 1992, the EMS was in effect already a monetary union, but operated by the Bundesbank, not the proposed ECB. Repeating the analysis of non- German EC member countries' business cycles indicated, however, that they were all less synchronous with Germany's than with the Community average; those proposing that the Community move to a monetary union or indeed to any fixed rate system managed by a new Community institution rather than the Bundesbank therefore face great difficulties in making a strong case why Germany should wish to become a member.