Quo vadis, Euroland?

Stage Three of the European Monetary Union (EMU) will start on January 1, 1999. The new currency area, for which the name "Euroland" has been coined, will comprise 11 countries: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain. The project of a single currency has enhanced economic convergence among the participating countries to some degree, but differences with respect to the business cycle have remained pronounced. This can also be expected for EMU. A single monetary policy for Euroland will not affect regions uniformly, given the substantial differences between the participating countries with respect to, for example, institutional arrangements in financial markets and in labor markets, the public share in the economy or the structure of production. It is often argued that monetary policy in Europe is currently too tight; consequently, the upswing is at risk or even deflation is around the corner. This view is not supported by the facts. Various indicators suggest that monetary policy is actually quite easy. Given that European short-term interest rates are bound to converge around summer at a historically low level and key interest rates will hardly be raised substantially in the immediate future, monetary policy will remain loose for the time being. This policy increasingly bears some risk of accelerating inflation. In any event, there is no risk of outright deflation in Euroland. It is still an open question whether the European Central Bank (ECB) will use a monetary aggregate as an intermediate target (monetary targeting) or try to directly adjust monetary policy to (forecasted) inflationary developments (inflation targeting). Empirical work suggests that money demand in Euroland is sufficiently stable to pursue monetary targeting. Even if instability were to occur in the transition period and right after the introduction of the euro, this would not necessarily imply the superiority of inflation targeting because under such circumstances the reliability of inflation forecasts is reduced as well. The advantage of implementing the monetary targeting strategy that had proved to be successful in Germany would be that it allows the ECB to gain some of the Bundesbank's reputation. In 1997 public deficits in all countries of Euroland were kept within the limit of 3 percent of GDP set in the Maastricht Treaty. However, further consolidation is necessary in most countries in order to meet the obligations of the Stability and Growth Pact. Ultimately, the fiscal positions have to be sustainable in the long term. A rough calculation suggests that at present only a few of the prospective EMU countries have a sustainable fiscal position. In addition, fiscal policy seems to be less sustainable because in some countries one-off measures contributed significantly to the reduction of the 1997 deficits. After EMU is established, bilateral exchange rates as possible shock absorber cease to exist and other mechanisms of adjusting to a negative (external) shock are necessary in order to prevent unemployment from rising. The most important adjustment mechanism left is flexibility of wages. It would be counterproductive to increasingly negotiate wage settlements at the European level. Against the background of the rising need for differentiation, decisions that affect employment should, to the contrary, be more and more decentralized.