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During its first decade the European Monetary System has more than fulfilled the ambitious goals of its founders, macroeconomist Niels Thygesen told a lunchtime meeting on 9 September. The meeting was organized by CEPR and the London office of the Commission of the European Communities to mark the publication by Cambridge University Press for CEPR of The European Monetary System (edited by Francesco Giavazzi, Stefano Micossi and Marcus Miller), for which Thygesen wrote the introductory chapter. The conference on which the volume was based, which was organized by CEPR, the Banca d'Italia and the Italian research network STEP, is reported in more detail in Bulletin No. 24/25. Niels Thygesen is Professor of Economics at the University of Copenhagen and a member of the Delors Committee appointed in June to consider the means of achieving European economic and monetary union. The opinions he expressed were his own, not those of the Commission of the European Communities or of CEPR, which takes no institutional policy positions.Thygesen began by noting that the EMS has attracted great attention as a framework for policy coordination since its conception in 1978. Disillusioned by the prospects for global monetary reform and by the performance of floating exchange rates, the founders of the EMS wanted to restore a system of `fixed but adjustable' exchange rates and a zone of monetary stability. During the first ten years of its existence, it has moved beyond this: the System's exchange rate mechanism has become tighter, monetary policy coordination much closer, and capital mobility has increased significantly. The European Monetary System contains, according to Thygesen, the most thorough assessment to date of the impact of the EMS on the broad macroeconomic performance of its participants. The impact of the EMS on inflation should be the easiest to substantiate, since it is often described as a framework designed to discipline those participants who have relatively high inflation rates. But why do these countries choose to disinflate within the EMS rather than pursuing this goal on their own? The investigations by Giavazzi and Giovannini and by Collins show that the decline in inflation in the EMS was initially slower than in, say, the United Kingdom; but since 1983 it has also proved to be more persistent than in countries outside the System. For the weaker currencies EMS membership appears to have reduced the adjustment costs of moving to a lower inflation rate, relative to what they would have had to undergo on their own, and may have smoothed out the costs of dollar fluctuations. Melitz observes that Germany has also benefited from the tendency since 1983 towards real depreciation of the DM against most of her trading partners in the EMS. Members have also experienced less volatility and temporary misalignment of their exchange rates than has been experienced by most individually managed currencies. While many observers had feared that reduced exchange rate volatility could only be achieved at the expense of increased interest rate volatility, the chapter in the volume by Artis and Taylor suggests this has not happened. This result may be of special relevance to the United Kingdom, Thygesen noted. But has the EMS moved too far towards convergence of inflation rates? In his chapter in the volume, Dornbusch argues that it has: further disinflation in Greece, Italy, Portugal and Spain might prove too costly both in terms of output loss and because governments in these countries would find it difficult to replace the seigniorage that is automatically available as the monetary base grows roughly in step with nominal income. Dornbusch also finds that full liberalization of capital movements may require more exchange rate flexibility for financial transactions than EMS participants seem ready to consider. But the pace of financial integration has accelerated with the decisions taken by the EC Council of Ministers in June 1988. The EMS will, therefore, have to find ways of resolving the tensions caused by its conflicting ambitions, according to Thygesen. It must also make appropriate transitional arrangements for those EC members who are not yet ready for the degree of convergence and policy coordination presently required by the System. The tensions that arise from growing trade imbalances are analysed in the chapter by Vona and Bini Smaghi. Their analysis makes clear in quantitative terms that the acceptability of disinflation within the EMS depended heavily on the rise of the dollar and the relative US boom in 1983-5, which cushioned output losses and helped preserve external equilibrium. Their empirical results also suggest that some redistribution of demand through fiscal policy would eliminate the existing trade imbalances within the EMS much more efficiently than exchange rate realignments within the System. The European Monetary System also explores the issues of short-run monetary management and coordination within the System. The tentative answers that emerge are more differentiated than widely held beliefs: while the Bundesbank has been able to retain a domestic monetary target and to sterilize effectively a large part of her foreign exchange interventions, other countries have also been able to reverse capital flows without increasing the volatility of interest rates. How will the EMS function as capital controls are fully removed by 1990? Driffill argues that by allowing exchange rates to move within the EMS band and keeping realignments sufficiently small, the System may well find a way of preserving exchange rate stability under near-perfect mobility of capital. The chapter by Russo and Tullio examines how monetary policy coordination could be made more explicit in the EMS. They envisage a reform in which the System would become more symmetric. Proposals could include the coordinated setting of targets for domestic credit expansion, nominal income growth in each country, or a European price index. In a concluding chapter, Tommaso Padoa-Schioppa gives a long-run perspective. He outlines how the ECU could evolve, with minimal institutional changes, into a common monetary base for Europe to help the EMS cope with full capital liberalization. Thygesen concluded that the CEPR volume provided the most thorough evaluation now available of the impact of the EMS on the macroeconomic performance of its members. With its insights into how the System might evolve, as the internal market is completed and as capital controls are liberalized, it would be required reading for those serving with him on the Delors Committee. One member of the audience compared the experience of sterling in the 1980s with that of non-German EMS members. The latter had apparently gained from systematic overvaluation against the Deutschmark, but the UK experience of 1979-80 was of a very sharp appreciation which, it is argued, had subsequently brought benefits. Why should the experiences of the EMS members be preferred to that of the UK? Thygesen replied that the main benefit from the System was the convergence of inflation rates. Other benefits to UK membership included those associated with financial integration, but it may be possible to obtain them outside the EMS |