Stability, Asymmetry, and Discontinuity: The Launch of European Monetary Union

Abstract

ALTHOUGH STILL LESS than one year old as this volume goes to press, European Economic and Monetary Union (EMU) is already under trial, charged with at least three offenses. The first is false advertising: Europeans, it is claimed, did not get the strong, stable currency they were promised, for within seven months of its birth the euro had lost 13.5 percent of its value against the dollar. The second is obfuscation: markets are finding the signals from the new monetary institutions confusing and inconsistent, and a scarcity of relevant information--from delays in releasing reliable euro area--wide statistics to lack of access to the deliberations of the Governing Council--makes it difficult to forecast economic developments and to understand the policy conduct of the new European Central Bank (ECB). The third is lack of impartiality: the ECB's new policies are claimed to be exacerbating asymmetries between fast-growing and slow-growing countries and validating the presumption that the costs and benefits of monetary cohabitation are unfairly distributed among small and large member states. This paper espouses a rather different thesis. In terms of its impact on financial market integration and the ability of its institutions to cope with cyclical contingencies, EMU is performing well above expectations. And it is doing so even though persistent asymmetries across countries represent a threat to the ability of the new policy framework to guarantee economic stability and promote further integration in Europe. It is clearly premature to attempt even a first assessment of the new European monetary architecture--it will take quite a few years before the track record of the ECB becomes sufficiently long and rich for such an evaluation. This paper is instead devoted to the more modest task of casting light on early developments in the euro area and their potential implications for the future of EMU, surveying the main points in the current debate, noting contrasting positions, and evaluating those positions in light of the available evidence. Our synthetic but comprehensive overview of the first few months in the life of the euro is thus aimed at disentangling those facts, empirical evidence, and institutional details that we consider useful toward a balanced interpretation of the current monetary and financial evolution in Europe. The paper is organized as follows. We begin by placing our analysis of the swift launch of the euro in the context of the macroeconomic convergence and integration that took place in Europe following the 1992-93 crisis of the European Monetary System (EMS). We then discuss the monetary strategies of the European System of Central Banks (ESCB), reviewing the official positions taken and the main criticisms leveled in the recent debate. Next we focus on the instruments of monetary policy in the euro area and on liquidity management and money market integration. We then present an update of developments in the bond and equity markets and a preliminary assessment of public debt management strategies by the eleven independent sovereign states coexisting in the euro area. We go on to deal with some open issues in the euro area banking sector, comment on the behavior of the euro in the currency markets, and analyze asymmetries across European regions and their implications for centralized monetary policy. Finally, we review the process of fiscal consolidation and the debate on the code of budgetary discipline in Europe.(1) The Launch of the Euro in Historical Perspective From a technical standpoint, the euro was born on December 31, 1998. That was the date when the fixed conversion rates among euro area currencies were determined, and thus when the national currencies were demoted to nondecimal denominations of the new currency.(2) It was also the start of the changeover weekend, during which clearing and settlement systems were retooled and trading positions and accounts redenominated from the old currencies into euros. …