At a Brussels lunchtime meeting at ECARE, Université Libre de Bruxelles on 1 December, José Viñals suggested that the right question at the onset of the 1992–3 ERM crisis was not, as most people asked, `why did it happen?', but rather `why didn't it happen earlier?'. Over the 1987–92 period, significant tensions were accumulating below the surface of the ERM, which progressively undermined the foundations of exchange rate stability. Viñals stressed the importance of understanding these sources of the crisis since they reflected fundamental problems which, if unresolved, will not only jeopardize a return to stability in the medium term, but could also make it impossible to implement the Maastricht Treaty by the year 2000. Viñals is Head of Economic Research at Banco de España and a Research Fellow in CEPR's International Macroeconomics programme. His presentation was based on his Occasional Paper No. 15, `Building a Monetary Union in Europe: Is it Worthwhile, Where Do We Stand, And Where are we Going?', produced as part of CEPR's research programme on `Market Integration, Regionalism and the Global Economy', supported by a grant from the Ford Foundation.

According to Viñals, turmoil in the ERM was the result of two factors. The first was the insufficient coordination of monetary and non-monetary policies among Member States: this led to the emergence of competitiveness problems and policy dilemmas. The second factor was the absence of effective mechanisms to preserve exchange rate cohesion in the ERM during those periods when it was threatened by speculative attacks. Following the widening of ERM fluctuation bands, relative calm has returned to European foreign exchange markets. In addition, policy dilemmas have become less acute: reductions in German interest rates have been accompanied by better economic prospects almost everywhere. Ratification and legal enactment of the Maastricht Treaty has also contributed to reducing overall economic uncertainty.

Viñals envisages a return to narrow bands only under rather stringent conditions: enhanced coordination of national economic policies, and reinforced ERM cohesion to reduce its vulnerability to speculative attacks. Recent experience shows that ERM membership is a useful focal point for the coordination of national monetary policies, but not for fiscal policies and wages. In fact, throughout the EMS period, national budget deficits and wages have differed significantly. Consequently, inappropriate national policy mixes have often complicated the task of monetary policy, giving it the dual burdens of achieving price and exchange rate stability. Viñals argues that it is important to find ways of fostering policy coordination that work in both `good' and `bad' times, perhaps by establishing more explicit medium-term anti-inflationary goals to underpin target parities for EMS members' exchange rates. This would in turn put exchange rate stability on firmer economic grounds. National monetary authorities must also show a strong commitment to defending the parities they believe are justified by economic fundamentals. But since the unilateral defence of currencies may prove difficult, European central banks should devise and implement technical and institutional reforms of the ERM that improve its solidarity without jeopardizing price stability.

Viñals goes on to discuss the design of a single European monetary policy and the complexities of moving from a system of different national monetary policies, geared to a variety of objectives, to a policy oriented towards a single objective for the whole Union. The ESCB, a new institution, must maximize its antiinflationary credibility through a well-designed monetary constitution and through reputation. Compared to other central banks, the ESCB ranks high in terms of formal independence. This is important since empirical evidence indicates that the average rate of inflation is generally lower in countries with more independent central banks. Once the ESCB starts operating, it must demonstrate its effective independence and convince both the public and governments of its aversion to inflation. It may inherit some credibility at its birth since the credibility of monetary policy ultimately depends on the overall macroeconomic policy mix: the fulfilment of fiscal convergence conditions during Stage Two and the excessive deficit procedure provided for Stage Three should strengthen the ESCB's initial credibility. It could also inherit credibility from national central banks if they have achieved strong anti-inflationary credibility during Stage Two. The ESCB's success in fighting inflation will depend not only on its own policies, however, but also on the behaviour of the fiscal authorities. Germany's experience following unification demonstrates that even an independent and reputable central bank such as the Bundesbank can face difficulties in achieving its anti-inflationary objectives as a result of overly expansionary fiscal policies. But while inflationary risks might be posed by an `inadequate policy mix' for the whole Union, the provisions in the Maastricht Treaty oriented towards avoiding excessive budget deficit and public debt levels limit these risks. In addition, having a single European monetary authority may increase the chances of resisting the variety of pressures coming from national fiscal authorities.

Viñals then examines the main issues involved in the formulation and execution of future European monetary policy. These must be resolved for the ESCB to operate monetary policy efficiently and effectively from the beginning of Stage Three. Designers of the policy must consider whether intermediate targets (such as monetary targets) will be useful, as well as being aware of the tactical aspects of monetary policy execution: identifying the minimum requirements for guaranteeing uniformity of monetary conditions, and exploring the options available for executing policy in a decentralized form through national central banks. Viñals concludes by defining `the minimal requirements for the conduct of a single European monetary policy'. The most important is the integration of national interbank markets to ensure that interest rate arbitrage brings about a single monetary stance throughout the Union. This must rest in turn, on the integration of national payment systems, permitting credit institutions rapidly to transfer their interbank positions across borders and achieve final settlement within the same day. Greater uniformity among national monetary policy instruments and procedures would also be desirable in order to prevent regulatory &nbsparbitrage and shifts in financial location resulting from differences in the cost-subsidy mix implicit in the way monetary policy is managed.