Policy Coordination, Labor Market Flexibility Crucial To EMU's Success

• Pages: 333-336

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In May 1998, European Union (EU) leaders will decide which countries will participate in European economic and monetary union (EMU) from its outset, following the design agreed at Maastricht in December 1991. The establishment of EMU, scheduled for January 1999, will constitute an unparalleled development in the history of the international monetary system. The replacement of the national currencies of a number of highly developed economies in the EU by a single common currency-the euro-will be the culmination of over 40 years of progress in strengthening economic, monetary, and political ties. How will monetary and fiscal policies be conducted in the euro area? How will participating economies adjust to diverse developments in the absence of exchange rate flexibility and national monetary policy? And how critical are labor market reforms for EMU's success? These are among several questions addressed in the October 1997 World Economic Outlook and in a recent IMF Working Paper on the EMU.

The EU's current monetary system, established in 1979 with the aim of providing a zone of monetary stability, has at its core an exchange rate mechanism (ERM). The anchor role of the deutsche mark under the ERM has meant that the Bundesbank's policy- aimed at price stability in Germany and set primarily on the basis of domestic considerations-has had a dominant influence on monetary policy. By contrast, under EMU, the scope for national monetary policy- and the Bundesbank's dominant influence-will disappear. Monetary policy will be the exclusive preserve of the European System of Central Banks (ESCB), comprising the European Central Bank (ECB) and the national central banks. The ESCB's primary objective will be to maintain price stability.

Fashioning a Common Monetary Policy

The prospect of a common monetary policy in EMU has given rise to several operational issues, including the independence and accountability of the ESCB, the strategy and intermediate targets to be used by the ECB in pursuit of its objectives, and the differences among member countries in how monetary policy instruments are transmitted to the real economy. Independence and Accountability.The independence of the ESCB is well safeguarded, as various Maastricht Treaty provisions insulate it from political influence, notes the World Economic Outlook. The treaty precludes member governments from influencing ECB decisions and prohibits ESCB financing of government deficits orPage 334 EU institutions assuming the commitments of governments. Moreover, while the EU's Council of Ministers has the right to enter into formal agreements relating to exchange rate arrangements for the euro or to formulate general orientations for the exchange rate, the rules concerning...