Sustained reform of economic policies and structures has been identified by the European Commission as a condition for peripheral nations and regions to benefit from EMU, especially in the face of limited labour mobility and low capacity for fiscal redistribution. It has also been demonstrated by retroactive simulations that, had the ‘stability and growth pact’ been applied over the 1961–97 period, it would not have exacerbated recessionary forces. These views were expressed by Jorge Braga de Macedo (former Portuguese Minister of Finance, Universidade Nova de Lisboa and CEPR) at a meeting jointly organized by CEPR and The Royal Bank of Scotland, whose Treasury and Capital Markets group acted as hosts. Braga de Macedo warned that if countries used EMU to hold up necessary reforms, then the benefits of the euro might vanish both at the core and at the peripheries.

In reviewing the progress made by EU members towards economic reform, Braga de Macedo noted that most countries had shifted towards a more disciplined fiscal and a more stable monetary regime after realizing that they could no longer improve their export competitiveness by engineering exchange rate devaluations. The trend had begun after the creation of the ERM in 1979, with the Netherlands forgoing devaluation after 1982 and France after 1983. Poorer states had taken longer to be convinced, but the economic regime had changed in Ireland after 1987, in Spain after 1989 and in Portugal after 1992. In Greece and Italy, the changes had been even more recent.

Looking ahead to the benefits of EMU, Braga de Macedo argued that stability-oriented policies would allow the effects of replacing national currencies with the euro to differ not so much spatially, by the geographical location of the state, but rather according to credit ratings. The implication was that, since ratings reflected the ability to service debt in the future, firms located in the peripheries might benefit more than those located in the core, as long as national and regional policies had sufficient credibility. Benefits would also flow if the assumption that the ‘rules of good housekeeping’ of the gold standard would be matched by the combination of the euro and the stability pact was to be realized. We would then have what might be called the ‘euro standard’. While some features were still unclear – e.g. whether the European Central Bank would be accountable to the European Parliament, national parliaments, both or neither; and by whom the euro exchange rate against the dollar or the yen would be determined – such design problems were likely to be overcome by appropriate institutional evolution and awareness among members of the benefits of cooperation.

Differences between core and peripheral countries would be slow to erode, however. For the core currencies, since the choice of members and the locking of parities would now be simultaneous, greater resort to financial instruments and more effective central bank cooperation might suffice to discourage speculative attacks on the parities perceived to be weaker. But, even though the ERM will remain as a convergence instrument, currencies in the peripheries will continue to be subject to the lingering influence of ‘geographical fundamentals’ and other monetary myths. Myths from a misperceived historical experience interact perversely with geography, since the reputation of a state in the periphery of an international currency standard may differ from that of a state in the core. This had previously been true of the geography of the gold standard and, basically, it reflected the role of politics.

In the case of Portugal, the multilateral surveillance procedures of the ERM had enhanced national credibility abroad even before the policy had been accepted at home.

Thus, the difference with the currency crises in emerging markets from Latin America to Asia, let alone in Central Europe, lay in the expectation that stability-oriented policies would not be questioned in future elections. As the preference for stability was revealed at home and abroad, the benefits of policy credibility to economic activity and employment were becoming more apparent: Portugal’s unemployment rate, for example, had been around 7% – one-third of Spain’s.

Turning to the current ‘state of play’ on potential membership of EMU, Braga de Macedo claimed that, in the wake of the ‘social’ emphasis introduced by the election of the new French government in May 1997, the likelihood of Italy joining was now almost the same as that of Portugal or Spain. On the one hand, market sentiment remained such that the euro would be perceived to be too weak if Italy was included; on the other hand, while Italy was one of the EU’s major financial peripheries, it was at the political core of the Union. It could not therefore be alone with Greece and the ‘opt-outs’ (Denmark, the United Kingdom and Sweden) in being outside EMU.

Returning to the policy-reform theme, however,
Braga de Macedo expressed concern about the fact, as he saw it, that the major uncertainty over whether or not EMU would begin on time had shifted from the financial peripheries to the core. Segments of European public opinion were disposed to give more salience to the dismal record on unemployment than to the possible benefits of EMU. Moreover, they were still prone to the belief that there exists a lasting trade-off between inflation and unemployment. In this environment, national governments, fearing that further structural reforms could exacerbate political instability, might use EMU as an excuse for procrastination over essential changes, and so threaten to derail the entire project.