How to Safeguard General Support and Legitimacy of Monetary Policy during Times of Economic Distress in a Monetary Union?

The two recent macroeconomic shocks that hit the world economy - the surge of oil and food prices and the subprime crisis - have revived the attention of policy makers and economists on the consequences of shocks, symmetric and asymmetric, and on the appropriateness of the EMU institutional framework to respond to these shocks. The briefing paper outlines the doctrine that underlies the ECB response to the shock, i.e. an exclusive focus on inflation, and argues that this policy is likely to be ineffective, while it will certainly have deep distributional consequences, having the same analytical effect as of a regressive tax on low income wage earners. The paper then discusses in more general terms how the European institutions face difficulties in the classical instrument/objective assignment problem, which stems from an excess of confidence in market adjustment mechanisms. This contrasts with the case of the US, where market forces and policy interventions complement each other in a virtuous way. The paper then concludes with a number of proposed changes in the economic governance of Europe, which would make the policy reaction to shocks easier and more effective.