Working Paper: CEPR ID: DP618
Authors: Michele Fratianni; Jurgen von Hagen; Christopher Waller
Abstract: This paper discusses the strategic choices involved in the transformation of the current EMS into a European Monetary Union. Alternative strategy proposals are evaluated under the criteria of credibility, flexibility, effective institution-building and mitigation of end games. The Delors strategy mistakes exchange rate fixity for credibility, resulting in an overly rigid and unstable strategy. The Hard Ecu provides flexibility, but is unlikely to achieve EMU. We propose a softened EMS - the Two-Tier EMS - as an alternative that meets the four criteria in a more satisfactory way. The second part develops a principal-agent model of the central bank, which embodies an explanation of political business cycles and the credibility problem. We use this model to show that the current draft of the statutes of the European Central Bank does not solve the dilemma of discretion and credibility in a satisfactory way.
Keywords: emi; monetary and exchange rate regimes; central bank constitution
JEL Codes: E42; E58; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Delors strategy (O52) | rigidity and instability in monetary policy (E63) |
| fixed exchange rates (F31) | incentives for governments to manipulate positions (D72) |
| softened EMS (I10) | enhance flexibility and credibility (L15) |
| narrower bands of currency fluctuation (F31) | accommodate idiosyncratic shocks (E32) |
| current ECB statutes (E58) | potential misalignment between monetary policy objectives and political pressures (E61) |
| institutional design (D02) | effectiveness of monetary policy (E52) |