Banking on Union?

THERE HAS recently been sharp debate about that centerpiece of European Union (EU) planning, the European Monetary Union (EMU). In the run-up to the 1996 conference to review the EU's Maastricht Treaty -- and leaving aside those who dislike the entire enterprise -- three major schools of thought have emerged. One holds that not only a common market but even monetary union can be had without political unity. Monetary union, it is maintained, is a technical issue, designed to do away with exchange rate fluctuations, transaction costs for business, and other uncertainties. A new and independent European central bank could run such a regime, as independent central banks in Germany and the United States have done for decades, leaving political roles, including the management of national fiscal policies, unaffected.

Another view -- strongly held, for instance, by Chancellor Kohl and in France -- is that Emu is desirable for overriding political reasons, irrespective of formal political union. Once achieved, it will in any case promote further integration.

The third view -- insisted on by the German Bundesbank -- holds that if Emu is to succeed it must be accompanied by political union.

Two clusters of issues are involved here. One concerns the nature of the central bank and its independence, another the more technical issues of monetary management.

A prominent argument in favor of a European central bank has been that its political independence, modeled on the U.S. Federal Reserve and the Bundesbank, would ensure that economically sensible monetary policies are not distorted by short-term political pressures. But for both the Fed and the Bundesbank independence has special characteristics. Each is indeed free from day-today interference. Each can take decisions, especially on short-term interest rates, that the U.S. president or the German chancellor of the day might rue. On the other hand, neither is independent of its national political system. Each is well aware of the fact that the legislation under which it operates is not immutable. Their strengths rest, precisely, on the way in which each takes care to operate with, and not against, the grain of responsible financial, political, and public opinion. Each has been consistently careful to maintain broad public and political support for its independent role. John Goodman has made the point with respect to the Bundesbank:

This does not mean... that the Bundesbank has never acceded to domestic pressures. Its independence is not written in stone; its enabling law can be changed. To maintain that independence, the Bundesbank has been forced to take the views of West Germany's major societal actors into account. In practice, the bank has always sought to build a coalition of supporting groups or, at minimum, to avoid uniting too many powerful interests in opposition.(1)

Parallel observations can be made about the U.S. Federal Reserve, given its regional sensitivities and the concerns that a chairman like Alan Greenspan has usually displayed for fiscal and general social conditions. In other words, each of these independent central banks operates within a sovereign and structured political and economic system. Each has relatively clear-cut legal obligations. Each operates under laws resting on the authority of legislatures with direct electoral legitimacy.

Nothing remotely comparable is in prospect for a European central bank. The EU does not have, and is not within the foreseeable future likely to acquire, the character of a unified political and economic system from whose interests a central bank could take its bearings. Politically and administratively the EU seems sure to remain, at least for some time, a conglomerate of somewhat differing interests, attitudes, and policies. The bank's statutory independence would be a supranational artifact, its authority derived from state executives with widely differing perspectives and electoral mandates. If the members of its Board of Governors retained strong links to their nations, the Board would probably lack much intellectual, let alone political, coherence. If they did not, the Board would be a technocratic entity operating, unaccountably, in a near political and social vacuum.

On the other hand, it might simply come to be dominated by the strongest member state. Helmut Schmidt remarked long ago that Western Europe had, in effect, become a D-mark area. But if the D-mark is already a de facto European currency, it is not entirely clear what additional functions a new European central bank could usefully perform, except to hobble the Germans by transferring power from the Bundesbank to a bank in which the French, Italians, and others would be directly represented. It is this political aim which fuels French support for EMU.

All that helps to explain the view of the current Bundesbank president, Hans Tietmeyer, that a European Monetary Union not embedded in political union would either collapse or lead to inflation. This is based on a strong conviction, by the public as well as in the bank, that German prosperity is largely based on monetary stability, low inflation, and a strong D-mark, none of which should be lightly abandoned. It is also based on the view that equivalent stability cannot be guaranteed by an Emu in a non-unified EU. That is because market mechanisms by themselves cannot generate national wage and fiscal policies designed for overall stability. Only a central political authority, determined to keep inflation low, could do that. Only in such a regime could fiscal, wage and monetary policies be adequately coordinated. Only a currency so based might hope to be as reliable as the D-Mark.

Recent experience has confirmed Bundesbank views about the unreliability of politicians and the impossibility of effective macro-economic policy coordination in any circumstances short of full political union. In the 1990s even the German government, under the pressures of national reunification, devised imprudent fiscal policies which, together with difficulties over income distribution, produced inflationary pressures. These in turn compelled the Bundesbank to maintain higher interest rates, at the cost of considerable pain for Germany's European partners. In a loosely organized political system it would be only too likely that some national fiscal and wage policies would conflict with central monetary policy. Nor would individual countries necessarily accept central bank decisions tending to disadvantage them. In such an Emu, inflationary pressures could be even greater than those in Germany after unification.

It follows that neither the bank's statutory independence nor adherence to the agreed criteria for joining the EMU would be enough. Under the Maastricht Treaty, the exchange rate of a country applying for EMU membership must have been stable for two years beforehand. Its long-term interest rates should be within two percentage points of the average of the best three performers and its inflation rate within one and a half points of this average. Its public debt should not be greater than 60 percent of GDP.

But there is no agreement on how those conditions should be interpreted. The Germans, especially the Bundesbank and the Finance Ministry, want the convergence criteria met strictly, without fudging. They also insist that the criteria have to be met at an average position on the economic cycle, not just at the peak. If that interpretation were adopted, even by 1999 only Britain, Denmark, France, Germany, Luxembourg, and the Netherlands could qualify.(2) An unofficial European hard core such as this the EU would surely prove to be politically, socially, and regionally divisive.

In contrast, the EU C interpret those criteria flexibly, permit the inclusion of a majority of members. It argues, for example, that a country's debt levels only need to move steadily toward the 60 percent figure.

In part, this reflects a technocratic view about how Europe could be regulated and administered into unity, the awkward initial politics were overcome. It also reflects the views of a majority of EU finance ministers, including the French and the British treasurers, who wan EMU largely for political reasons, especially to limit the role of Germans in the EU.

Yet such an arrangement would create huge risks, not confined to the political divisions between core and periphery. A European bank so far removed from accountability would have questionable authority. There would be endless scope for financial speculation in a Europe divided between a central EMU and the other currencies. There would also be conflicts arising from disparate national wages, fiscal and debt management policies, and a central EMU monetary management.

It is hardly surprising that these prospective difficulties have already created severe tensions: in Britain, Denmark, and even France, between Euroenthusiasts and Euroskeptics or between Euroenthusiasts and national fulfillment in membership of a united Europe, and those who fear a swamping of national identity by a bureaucratic juggernaut; in Germany between the (largely Catholic) establishment in Bonn, which wants to fulfill large European aspirations, and Germany's economic and financial community, not to mention broad sectors of its public opinion, which worry about losing the D-Mark. Ironically, the German financial world agrees with Britain's Eurosceptics that control over monetary policy is a fundamental aspect of sovereignty. The disagreements are about whether that sovereignty could or should be transferred to the EU. Whatever forms the debate about political union may take -- and public opinion in many places seems increasingly skeptical -- the idea of a common currency and a common central bank without it is surely an illusion.

(1) John B. Goodman, Monetary Sovereignty: The Politics of Central Banking in Western Europe (Ithaca, NY: Cornell University Press, 1992), pp. 100-1.

(2) The starting date for EMU was to have been 1997, but last June the EU finance ministers, led by the British, French, and Germans, agreed that the required economic conditions could not be in place by then. It was agreed to plan for 1999.