The Transition to EMU: Issues and Implications

4 Colum. J. Eur. L. 359 (1998)

Peter B. Kenen. Walker Professor of Economics and International Finance and Director of the International Finance Section, Princeton University.

Three decisions will be taken in the spring of 1998 to prepare for monetary union in Europe, due to start on January 1, 1999. First, the eligible countries will be chosen. Second, the European Central Bank (ECB) will come into being through the selection of its six-member Executive Board, including the President and Vice-President. Third, the participating governments will choose the permanently fixed exchange rates at which they will enter the monetary union in 1999. This paper reviews the procedures and criteria that will govern those decisions, examines the problems that must be resolved, and assesses the implications for the subsequent functioning of the monetary union-for the conduct of monetary policy by the ECB, for economic performance in Europe, and for the behavior of the euro-the new single currency-on the foreign- exchange market. Other papers at this conference will examine more thoroughly the monetary policy of the ECB and its international ramifications. I plan merely to suggest how the 1998 decisions are likely to influence subsequent developments.


When monetary union was first seriously discussed in Europe, thirty years ago, a debate began about the question of convergence. Some protagonists of monetary union, the so-called economists, held that the members of the union should be required to achieve economic convergence before being admitted to the union. Another group, the so-called monetarists, held that this task of economic convergence could be left to the constraining effects of the union itself. There was, in addition, a vigorous debate about fiscal policies. Would the financial constraints imposed by the union discipline national policies, or would there be need for formal rules and arrangements? And if there was need for deliberate coordination, should it begin before or after the formation of the union?

Because a monetary union imposes a uniform monetary policy on its member countries, it tends also to impose a uniform inflation rate. There can still be long-lasting regional differences in levels of consumer prices as well as small differences in the rates of change of prices. There are indeed such differences within the United States. But there cannot be large, long-lasting differences between the members’ inflation rates. A monetary union need not result in convergence on levels or growth rates of output and employment. In fact, it can amplify differences in real economic conditions when its members experience different shocks and there is insufficient wage flexibility or labor mobility in the union. And though the members of a monetary union will have very similar short-term interest rates, the union will not necessarily impose tight financial constraints on public-sector borrowers of the sort that would prevent participating governments from pursuing independent fiscal policies.

When monetary union was discussed again in Europe during the late 1980s, the old debates broke out anew. French descendants of the “monetarists” wanted to move quickly to monetary union, which, they said, would induce automatically the requisite convergence of national inflation rates. German descendants of the “economists” wanted to move slowly and to admit to the monetary union only those countries that had vanquished inflation on their own and thus proved their commitment to price stability. In this and most other instances, the German view prevailed. Furthermore, the central bankers who wrote the Delors Report insisted predictably on safeguarding the independence of the ECB and on prohibiting large budget deficits.

In light of these concerns, Article 109j of the EC Treaty sets out an elaborate process for deciding whether a particular country is ready to join the monetary union, and the provision gives a great deal of weight to the degree of “sustainable convergence” already achieved by that country. In addition, Article 104c contains an outright prohibition on “excessive” budget deficits, which is now reinforced by the Stability and Growth Pact.