An Update On The Euro

To be sure, the Germans have been making all possible efforts to ensure that the European Central Bank (ECB) would be as independent of political interference, and as committed to price stability, as the Bundesbank. The European Monetary Institute, the precursor of the ECB, has come out with a blueprint for the ECB's monetary policy and instruments. These will be aimed at giving signals to markets on monetary policy, and consist mainly of open market operations. Besides, the report envisages two standing facilities for the banks : an overnight lending facility for the banks, in effect a ceiling on money market interest rates, parallel to the Bundesbank's Lombard Rate; and a deposit facility providing a floor for the overnight interbank rate. While there is no parallel to the floor in the German monetary system, the other instruments are clearly lifted from the Bundesbank.

 

As for the objectives of monetary policy, the EMI report has left it to the ECB to choose between a money supply target, as the Bundesbank does, or an inflation target, as the Bank of England pursues. There are of course several variants of combining the two. Recent studies (e.g, Is there a role for monetary aggregates in the conduct of monetary policy? by Arturo Estrella and Frederic Mishkin of the Federal Reserve Bank of New York, NBER Working Paper No 5845, November 1996) suggest that reliance on monetary aggregates is not a very good idea. The paper finds little correlation between growth in M2 in the US and future inflation or nominal income. The result is not much different if you use other measures of money supply in the US or in say Germany. Overall, the ECB is unlikely to rely heavily on monetary aggregates, which could be even more misleading for the euro-countries together, given the variances in the way statistics are collected, banking systems and practices, etc. The choice of an inflation target

may therefore be more likely.

If every effort is being made to give substance and power to the ECB, the Stability Pact agreed in the December EC summit is aimed at ensuring fiscal discipline in member countries, post-EMU. While the fiscal deal fell short of Germany's insistence on automatic sanctions should fiscal deficit go beyond an agreed level, it goes a long way towards meeting Germany's objectives. The pact permits higher deficits in the event of a natural disaster