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At a Brussels joint lunchtime meeting with the European Centre for Advanced Research in Economics (ECARE), Université Libre de Bruxelles, on 20 April, Michael Artis argued that EMU can still be achieved, despite the effective collapse of the ERM. Artis is Professor of Economics at the University of Manchester and a Research Fellow in CEPR's International Macroeconomics programme. His talk was based on his CEPR Discussion Paper No. 928, `Stage Two: Feasible Transitions to EMU', produced as part of a CEPR research project on `The European Monetary System: Sustainability, Operation and Long-Term Credibility', supported by the Leverhulme Trust. The views expressed by Artis were his own, however, not those of the Leverhulme Trust, ECARE or CEPR, which takes no institutional policy positions.Artis noted that the speculative crises of 1992-3 appeared to have dealt a severe blow to prospects for EMU. Maintaining currencies within the `normal' bands of the ERM for two years had until then seemed the least difficult of the Maastricht Treaty's `convergence criteria'. The establishment of the European Monetary Institute (EMI) in January 1994 did nothing to ameliorate concerns that similar speculative attacks could prevent a transition to full monetary union, since its remit is to consider the instruments and policies the European Central Bank (ECB) will require in Stage Three, not to make policy for Stage Two. While the EMI may `formulate opinions or recommendations on the overall orientation of monetary policy and exchange rate policy', these can have no binding force. Artis noted that the Maastricht Treaty's wording allowed countries participating in the ERM to retain its current `temporary' <F128M>æ<F255D>15% bands simply by agreeing to define these as `normal' and abandon the previous interpretation based on the <F128M>æ<F255D>2.25% narrow bands. The other convergence criteria could then remain intact or even be hardened to compensate for the resulting loss of credibility. This would undermine the entire rationale for introducing the narrow-bands convergence criterion, however, which was to provide a `proving ground' in which countries experienced the effects of `monetary disarmament' before making the final commitment to EMU. Artis therefore considered three means of renarrowing the bands to preserve the spirit of the `proving ground' interpretation while reducing the opportunities for destabilizing speculation. First, the narrow bands could be accompanied by capital controls to protect currencies against speculative attacks, but this would provide no incentives for national governments to adopt appropriate macroeconomic policies. Second, more flexible narrow bands with indexed central rates and soft edges could deter speculation by removing `safe bets', but unless a `nominal trigger' were explicitly incorporated this would also remove the discipline associated with hard-edged nominal bands. Artis therefore recommended a return to hard-edged, narrow bands in conjunction with a gradual transition towards a more symmetric European monetary policy. The `transition' proposed by the Maastricht Treaty is not transitional: transferring the conduct of policy from national central banks to the ECB at the start of Stage Three entails a `Big Bang'. National central banks should instead continue to conduct monetary policy during Stage Two, following the lead of the Bundesbank, which should act on the EMI's recommendations rather than responding solely to German concerns and objectives as its current statutes dictate. A growing body of research suggests that European financial integration has undermined the Bundesbank's traditional policy of exercising monetary leadership by sterilizing the reserve flows that stem from its participation in the EMS. Since domestic and foreign assets are now close substitutes, attempts to control domestic money will merely increase exchange rate volatility; the aggregate European monetary supply is now at least as good a predictor of inflation as the domestic money supply in nearly all ERM countries, including Germany. A return to narrow bands in Stage Two, on whatever basis, is only likely to be able to resist speculative attacks through the coordination of EMS members' macroeconomic policies, which will require their prior agreement both to accept the EMI's advice and recommendations and to commit themselves to unlimited intervention obligations. Such a proposal would clearly make the EMI a central bank in embryo. |