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Monetary Policy within the Economic and Monetary Union

Towards a Renewal of Research Themes in Europe

Monetary policy decisions have taken on a dimension that would have been difficult to predict just a few years ago. Monetary policy looms today as the principal stabilising instrument economic authorities have at their disposal in Euroland. This is an unprecedented situation.

Monetary policy in Euroland
The situation in which European monetary policy finds itself is unique, especially if we compare it with predominant configuration of the European Monetary System1 in the early 1990's when the monetary tool was to say the least constrained by the objectives of foreign exchange. This situation can be contrasted with the heavy constraints on the use of fiscal policy for macroeconomic adjustment in the context of the economic and monetary union (EMU), and given the balanced budget targets imposed by the Growth and Stability Pact2.

Since monetary policy has become the prevalent instrument for economic adjustment in Euroland, European economists from the beginning have been observing it closely. The success of the transition to a fiduciary euro in January 2002 brought with it the conviction that an underlying change was taking place in the way Europe operates, both in economic terms as well as in ways of intervening in the economy. The use of monetary policy as practiced by the European Central Bank (ECB)* was the subject of a number of commentaries by economists, at the same time that new policy issues arose around the use and direction of these same policies at the national level in Western economies. Euroland is nonetheless characterised by some particularities which attract the attention of economists and constitute fruitful avenues of research and analysis for research departments in central banks or in public research organisations like the CNRS. Two of these research themes are singled out for treatment here.

Mixed policy channels
The first question to address is that of the channels by which monetary policy decision move within the EMU. Hard enough to identify within a typical national economy, they appear to vary substantially if we compare countries within the euro zone. When differences in the structuring of debt by private actors (consumers, investors) is taken into account along with the architecture of national banking and financial systems, it becomes very likely that centralized Euroland policy decisions have nonetheless distinct and varying effects from country to country. It is also quite likely that in the short term these differences make for a range of different macroeconomic trends in economic activity and inflation.
How should the ECB take this heterogeneity into account in its policy decisions? For one thing, it is clear that the Bank should use national economic data when deliberating and not just rely on Euroland-level aggregates. Secondly, Bank officials cannot rely entirely on their knowledge of national economies and conventional macroeconomic relationships when determining an “optimal” monetary strategy for the whole euro zone because in the medium term the transition to the euro will have repercussions on the behavior of European citizens in spending, price-setting, and money holding. This spells a range of uncertainty which should be taken into account by European monetary authority. In the longer run, the expansion of the Union will probably exacerbate this problem, especially since the test of Euroland's viability will be, among others, its capacity to absorb new members with divergent economic structures.

How should the Central European Bank communicate?
The second challenge to be faced in this matter is the question of what communication strategy should the Central European Bank adopt. Studies on the proper degree of transparency for central banks indicate that clear communication is an essential ingredient if monetary authority is to be delegated to an independent institution. The ECB is one of the most independent central banks in the world, and it must respond satisfactorily to demands for accountability. Most economists agree, however, that the institutional structure of Euroland and the wide margin of interpretation allowed by the Treaty of Maastricht* on monetary issues has led to a sub-optimal situation for central bank transparency.
It remains for the ECB to find adequate ways to render an account of its policy deliberations and decisions. In particular it must establish a clear method for announcing and explaining the actions it undertakes. This could involve an overhaul of the framework in which the general monetary strategy guiding the Bank's actions is defined. This would serve as an incentive for the Bank to disseminate credible information about the policies it intends to pursue.




Marc-Alexandre Senegas
Professor at University Montesquieu-Bordeaux IV
Groupe de recherche en analyse et politique économique (GRAPE)
CNRS-Université Bordeaux IV

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