At a lunchtime meeting on 13 September, Jacques Mélitz discussed the emergence of a single market for bank reserves in a European common currency area. Mélitz is a member of the research department of the Institut National de la Statistique et des Etudes Economiques (INSEE), Paris, and a Research Fellow in CEPR's International Macroeconomics programme. His remarks were based on his CEPR Discussion Paper No. 818, `Reflections on the Emergence of a Single Market for Bank Reserves in a European Monetary Union'. The views expressed by Professor Mélitz were his own, however, and not those of CEPR, which takes no institutional policy positions.

Mélitz stated that the introduction of a common currency for the European Community will inevitably lead to a single market in bank reserves as banks look for overnight money throughout the EC, and evidence from single currency areas elsewhere suggests that it will be highly concentrated geographically. National central banks will feel responsible to firms operating in their own countries and also have a substantial stake in the location of this new market. Once it is established, national central banks' ability to analyse and influence their own domestic markets will be seriously impaired. For example, any attempt to tighten domestic credit may simply induce capital flight, and central banks may respond to these new conditions by seeking to make their own jurisdictions more attractive.

Mélitz first considered a monetary union in which the new European Central Bank seeks only to secure aggregate monetary control. This requires it to take charge of legal reserve requirements and the interest rate range within which the national central banks may operate. If the latters' operating procedures are otherwise unchanged, their remaining discretion will influence the location of the new Community-wide market for reserves, on account of differences in the assets they purchase and their ability to influence the costs of interbank transactions. Active competition for the location of the interbank market is therefore to be expected, but allowing this to decide the outcome raises strong objections. First, locations in which banks currently borrow directly from the central bank would have a strong initial advantage. Second, competition that changes central banks' behaviour need not ensure an efficient outcome, since home dealers in some countries may be able to undercut their foreign competitors knowing that their central banks will bail them out. Third, the parameters of the new money supply function will remain uncertain so long as the competition continues, during which period the new European Central Bank's ability to receive and transmit signals in domestic markets will be impaired.

Implementing a centralized solution requires a uniform blueprint, however, which raises equally strong objections. Adopting the operating procedures of an EC member country's central bank would give the chosen country an initial advantage that would choke off all the competition from the outset, while the costs of introducing a new model would also be unevenly distributed since any blueprint will inevitably follow some national examples more closely than others.

Any such wholesale adoption of a uniform central banking model will therefore eliminate many differences in national traditions that could have survived and rapidly remove others that could have been phased out gradually, which may lead to a large measure of quite unnecessary reform. Since we have no theory of optimal central banking organization, there is also a danger of permanent welfare damage from the imposition of the wrong monolithic model, which could also be highly divisive as the financial sectors in member states that would have to change most would also object. It may in any case fail to offset the competition for the interbank market: even with Frankfurt as the seat of the European Central Bank and the Bundesbank model of organization adopted with a single call rate and Lombard rate everywhere, remaining small differences in costs, manipulated by self-interested national central banks with partly unsuspected residual powers, might suffice to move the market for interbank reserves to London or Brussels.