EMU and the International Monetary System

17 Relations Among the IMF, the ECB, and the IMF’s EMU Members

Thomas Krueger, Paul Masson, and Bart Turtelboom
Published Date:
September 1997
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Niels Thygesen

What will be the role of the IMF vis-à-vis the countries that join the third stage of EMU in 1999 or later? This is the important and challenging question that the organizers have put to Jacques Polak and me.

There is currently a very limited basis in official documents for answering the question. The likely candidates for participation in the initial group in EMU have been preoccupied with the internal workings of monetary union, and the January 1997 report by the EMI on monetary strategies and instruments in Stage III, EMI (1997a), does not discuss external relations of the euro area in any detail. The Articles in the Maastricht Treaty–notably Article 109–that refer to the external relations of EMU are somewhat ambiguous. The combination of centralized decision making on–and to some as yet unknown extent, implementation of–monetary policy with decentralized national budgetary policies, though subject to constraints on deviant behavior through the Stability and Growth Pact, makes the relationship between international institutions such as the IMF and the OECD and the participants particularly complex. On the side of the IMF there is apparently and understandably some caution in developing guidelines for the future relationships. Discussions in the Executive Board of developments in the EMU process appear so far to have been largely confined to informal seminars for the members of the Board. One has to agree with Bergsten’s paper in this volume that the subject has been neglected to a surprising degree.

Discussions are now picking up on the European side, however. The EU Monetary Committee, consisting of representatives of central banks and treasuries of EU member states, has recently begun to address the external aspects of EMU, albeit tentatively.1 Preliminary thoughts have so far taken the form of an annotated agenda, but it is far too early to say which views will in the end prevail. An agenda would comprise at least the following:

  • the exchange rate regime and policy for the euro;

  • decision-making arrangements at the European level on matters relating to EMU;

  • questions of external representation;

  • the international dialogue on the policy mix; and

  • the relationship between the euro area exchange rate policy and ERM II.

The list may be useful as a checklist and will be used in the following discussion. However, given the likely divergence of views inside Europe on some of the issues, it is hardly productive to try to guess what will actually happen. The task for an outside observer, justifying the failure by the organizers to find an official to address the topic, might rather be to discuss what ought to happen, that is, to move from the positive to the normative level. I shall try to do so, obviously speaking in a strictly personal capacity.

The organization of the rest of the paper is as follows. The next section discusses the transition to EMU and the potentially constructive role the IMF could play prior to the start of Stage III. The following section, based on a perceptive 1980 paper by Jacques Polak, looks at earlier IMF concerns about European monetary integration as a regional “competitor” to the IMF. These concerns may today appear outdated, but recalling them is useful as a reminder of the major changes in the way European monetary integration is envisaged today relative to the early days of the EMS. The paper then discusses how multilateral surveillance of policies within EMU could be organized and the related issue of representation of the EMU countries in the IMF. Next is a look at the “fringe” arrangements surrounding EMU–ERM II and relations with present and prospective EU member states without any fixed exchange rate regime with the euro—and how the IMF could monitor them. Finally, conclusions are drawn.

IMF Role in the Transition to EMU

The preparations for EMU are now at a critical stage. The EMI has, as required by the Maastricht Treaty (Article 4.2 of the EMI Statute) by the end of 1996 “… [specified] the regulatory, organisational and logistical framework necessary for the ESCB to perform its tasks in the third stage,…”2 This review was completed in time despite the postponement of the selection of the initial participants in EMU from late 1996 to the early months of 1998. But the effort was so demanding that it has crowded out any intensification of the coordination of current monetary policies (see Thygesen, 1997).

Like other forms of economic policies, monetary policy will remain a national responsibility for EU member states until the start of Stage III. However, the early vision of the EMU process was that Stage II would begin the transition from the coordination of independent national policies to the formulation and implementation of a common monetary policy in Stage III.3 In fact, not only has there been no experimentation with joint policy formulation or any delegation of operational tasks to the EMI, but the rule book for monetary coordination that existed when the Treaty was drafted (in 1991) in the form of the narrow-margins ERM was abandoned in August 1993, five months before the start of Stage II and the setup of the EMI. It has not been replaced.

European officials will argue that efforts toward formal coordination would have been superfluous in the recent period, since the continuing acceptance of the primacy of the price stability objective and improvements in most dimensions of economic convergence have brought about a broadly similar monetary stance, not only in the countries that have for some time been considered the most likely candidates for monetary union in 1999, but throughout most of the EU. In particular, all member states with the exception of Greece currently appear ready to meet in 1997 the nominal convergence criteria of having recent (CPI) inflation rates and 10-year government bond rates within the required distance from the three best performers (in terms of inflation). Nominal exchange rates have also, since the spring of 1995–the most recent period of turbulence and realignment–approached the low degree of short-run volatility observed in the most stable ERM period, 1987–91. The EU currencies that had overshot any equilibrium level outside the ERM in 1992–93, and in some cases moved even farther in early 1995, appreciated back to what are considered broadly sustainable positions in the course of 1996. The Finnish markka and Italian lira reentered the ERM with agreed central rates in the autumn of 1996. Although the volatility of the pound sterling–and the Irish pound drawn along with it–has recently become a source of concern, a surprisingly high degree of exchange rate stability has been achieved without explicit coordination efforts. So what is the problem, and what might the IMF say about it?

The problem is that the present relative calm seems unlikely to last until January 1, 1999, which remains the most likely starting date for Stage III. In the months preceding the selection of the first group of participants in March or April 1998, currency markets could become much more turbulent, as financial markets reinterpret the likelihood of various countries actually being ready.

In 1996–97 a “convergence play,” reminiscent of what happened in 1991–92 around the time of the Maastricht Treaty signing, has been in operation, favoring a very significant narrowing of interest rate differentials, particularly for the Southern European countries whose entry has become more likely. But the convergence of long-term interest rates is fragile and could quickly be reversed if the projected activity levels and hence budgetary figures look disappointing for these countries and—even more important—if Germany and/or France are viewed as likely to miss the Maastricht budgetary criteria, rekindling doubts about a delay of the start to Stage III. It is doubtful whether renewed divergence and the currency unrest that it would imply could then be contained simply by tight monetary coordination and a revival of large-scale interventions, which have not been observed since the widening of the ERM margins in 1993. But good working habits to contain turbulences must be discussed in advance of their arrival.

There is a further argument in favor of developing a sense of collective responsibility for monetary policy among the prospective EMU participants now. Policies in 1997 will be one of the factors determining the degree of price stability with which monetary union will start less than two years hence. That justifies considerable attention by the EMI to joint inflation forecasts by the EMU participants, so that they can be subjected to public discussion. The fact that it remains uncertain which countries will participate initially is not a valid counterargument; any forecast would be conditional and more than one may have to be made, notably to allow for possible participation from Southern Europe. That would in itself be a useful service, given the way in which the size of the union is seen in the public debate, probably excessively, as a determinant of the internal and external strength of the euro.

What could the IMF say on these problems in the context of its multilateral surveillance efforts? My own view is that the IMF could play a constructive role by stressing on the one hand its recognition of the economic and political factors that drive the EMU process, while encouraging the Europeans to implement the process in a way that minimizes the risks of backfiring, which would have negative implications from a global perspective.

The first part of this recommendation is essential. For a while after the widening of the ERM margins, the IMF staff appeared to applaud the added freedom of maneuver that this step was seen to imply for differentiated national monetary policies. IMF documents encouraged Germany’s partners to cut interest rates at the end of the 1991–93 recession and accept the likely exchange rate consequences of such steps. This advice overlooked the political momentum toward EMU, which made France and other countries anxious not to use their freedom but to preserve the option of keeping EMU as much on track as possible. It also overlooked Germany’s interest in not seeing an already excessively strong deutsche mark pushed further into appreciation.

Though the IMF staff and publications have subsequently become more positive in tone about the realization of EMU, the earlier experience combined with the perception that the IMF remains basically sympathetic to some exchange rate flexibility even inside the EU did tend to diminish the readiness to listen to IMF advice, even among officials who have had a long-standing association with the Fund.

This problem should disappear once Stage III begins as far as the initial participants are concerned. Then monetary union will have to be taken as a fact and advice will center on how to make it function as well as possible—from the global perspective, which is that of the IMF. But problems might persist regarding those countries entering later or not at all and the operations of the successor to the present exchange rate mechanism, now known as ERM II. The EMU participants will regard ERM II as a transitional arrangement, while international institutions such as the IMF could well see it as more permanent. There may also be disagreement between those in the EU—the large majority—who regard participation in an exchange rate arrangement as an essential preparation and apprenticeship for joining EMU and those, notably the United Kingdom, who are not convinced of this and would rather continue the present practice of national inflation targeting. The Fund staff, given the environment in which it operates, may have more sympathy for the latter view than for the former, but any advice will have to be carefully balanced by also taking into account the motivation of monetary union. These issues will be taken up again from a longer-run perspective in this paper’s penultimate section.

Despite these sensibilities on the European side, the transition poses no new problems. The Fund will (and should) continue to express some concern over the way in which budgetary consolidation is proceeding in Europe in an attempt to roughly meet the deficit criterion in 1997. As explained in Masson (1996), there is a tendency, given the pressure of time, to rely on tax increases and expenditure cuts of a one-off nature, including the postponement of public investment, rather than long-run reforms of major categories of expenditures such as pension and health care systems. With the adoption of the Stability and Growth Pact, the pressure to move in this direction will. of course, be kept up after 1997, but critical advice from the IMF and other outsiders will be helpful in this area.

This is also the case for structural reforms in the participating countries (notably in the labor markets, since goods markets should in principle have become more competitive as a result of the EU’s Internal Market) to improve adjustment inside the euro area. The IMF has, like the OECD, put much analytical effort into the monitoring of structural reforms, stressing the virtues of labor market flexibility designed to “… reduce the gaps between wage costs and productivity for the most vulnerable groups, including measures that better achieve social objectives without impeding job creation and job search.”4

Since policies in the areas of public finance and structural reforms continue to be a national responsibility after the start of EMU, these are clearly also issues that the IMF can address without raising questions about the legitimacy of its concerns. But it will be constructive to voice these concerns also during the transition, when they have tended to be pushed temporarily aside.

In the short term, the IMF and many of its non-European members may be tempted to criticize the process of short-term budgetary consolidation because it imposes deflationary pressures on the participants and on their trading partners. In some EU countries, major budgetary corrections have brought such dramatic benefits in the form of lower interest rates—Italy and Sweden are prime examples—that the offsetting stimulus may have been more important than the contractionary effects of tighter budgetary policies. In most countries where interest rate differentials vis-à-vis Germany had already largely disappeared, these contractionary effects cannot be fully offset through slowly declining interest rates and some joint depreciation vis-à-vis the rest of the world. But real interest rates have edged down and competitive positions have improved to an extent that seems to make the effort worthwhile. Fortunately the IMF has not repeated its negative assessment of joint budgetary consolidation in Europe, which was voiced in leaked confidential documents in 1992 shortly after the Maastricht Treaty was negotiated. The increasing attention to longer-run problems is constructive and should not be swamped by the unfortunate short-run impact of the budgetary consolidation process on European unemployment.

Earlier IMF Concerns About European Monetary Integration

At a conference in Geneva in December 1979, external relations of the then-planned European Monetary Fund (EMF), the intended successor to the EMS after a two-year period, were discussed. Jacques Polak (1980) raised a number of pertinent criticisms of the plans—from a personal perspective, but with his authority from long experience with the Fund. The EMF never materialized, in part because the plans in the end seemed to imply institutional changes that required prior Treaty changes, and in part because the first years of the EMS after 1979 were so turbulent that it became impossible to contemplate additional steps in 1981, as had originally been envisaged. Nevertheless, a review of the problems then foreseen with the EMF is instructive.

The EMF fell far short of the EMU project when a single currency developed a decade later, though it did represent a transfer of authority from the national to the European level. Its main aim was to consolidate the whole range of financing external imbalances—from central bank interventions at the short end to conditional balance of payments assistance at the long end—into a single institutional framework. The mixture of central banking and political functions was no doubt the main reason why Germany and some other European authorities objected strongly. The EMF looked like a powerful regional IMF.5

Polak (1980) lists a number of specific issues on which the IMF had concerns about competition from the new regional institutional framework that was developing: the creation of international liquidity, the granting of conditional credit, and the establishment of a regional rival to the SDR in the form of the ECU. It is understandable that these new European initiatives were seen as threatening the commitment that the European countries had made to a global perspective through their membership in the Fund. It is therefore relevant to ask whether these concerns also apply to the EMU process. On the whole, this appears to me not to be the case.

International liquidity has become a less important problem for the industrial countries, not least for the European countries. At the time when Polak wrote his article (in 1979), attention was already focused on the composition of international reserves rather than on their overall adequacy. In view of the weak dollar, plans had developed for a Substitution Account in the Fund, into which members could deposit a substantial part of dollars and receive SDRs. With the subsequent strengthening of the dollar, interest in the scheme faded and the perceptive idea of Polak that the EMF might itself deposit some of the excess dollars that were to be pooled with it into the IMF Substitution Account never reached the official agenda.

Since then the international monetary system has seen a near-quadrupling of reserves (excluding gold). While the dollar share of currency reserves has fallen somewhat and those of EU currencies, mainly the deutsche mark, have risen, the dollar share has remained well above 50 percent,6 and it is hard to foresee any resurrection of the Triffin dilemma that the size of official holdings might suddenly trigger anxiety, causing major holders to try to shift into other assets. Reserve creation by EU countries through current account deficits has been modest indeed, and that from EU institutions zero or negligible, depending on whether one regards the swap arrangements between individual central banks as a way of mobilizing gold reserves that would not otherwise have been readily usable or just as a substitution. As Polak noted, the most accurate way to describe the three-month swap arrangements between the EU national central banks on the one hand and the EMI7 on the other would be to see them as an allocation of ECUs, matched by immobilization of a corresponding amount—20 percent of gold and non-EU currency reserves—of existing reserve assets. There has been no net extension of short-term credit, though that possibility was foreseen in the original EMS documents.

However, there may be an indirect effect on the attitude of the EU member states to the evaluation of the adequacy of international reserves. The development over time of a relatively successful regional scheme of monetary coordination, building in part on commitments to intervention at the EMS margins that are in principle unconditional may have made Europeans less sensitive to reserve shortages perceived elsewhere in the international monetary system. Although the shortness of the intervention credits—initially 2½ months, extended in 1987 to 3½ months—has inspired caution in relying primarily on those credits to sustain exchange rates, the relatively reassuring framework may have prompted the Europeans to take a more restrictive attitude in discussions of SDR allocations and the size of IMF-led rescue operations, notably when the Mexican crisis arose. If so, such attitudes might harden further once monetary union has started.

There was an understandable concern in the 1979 Polak paper that the EMF might engage in significant extensions of conditional credit to member states on terms more favorable to borrowers than IMF conditionality. The member states of the EU could well be regarded as too narrow a club to insist on tough terms when extending loans for balance of payments adjustment. In particular, the EU is less independent of influence from EU member states than is the Fund staff when it comes to assessing the need for financial support for a country. Polak therefore argues in favor of recognizing the principle—as outlined in the stillborn safety net facility negotiated in the OECD in 1975—that a borrower should first make use of the IMF multilateral facilities in order to assure that supplementary facilities elsewhere are offered on the same terms.

There have been few instances of longer-term credits extended by the ECOFIN Council (notably, to Greece and Italy). Although these experiences have tended to confirm the relative softness of EU procedures (disbursements continued despite some transgressions of stated objectives), the amounts involved were relatively modest. They have since largely been repaid; the EMI (1997b) reports that at the end of 1996 the amounts outstanding were ECU 500 million in the case of Greece and nearly 3,500 million in the case of Italy (see also Polak’s paper in this volume). More important, the Maastricht Treaty (Article 103a) stipulates tough conditions for the granting of longer-term financial support to a member state. The ECOFIN Council has to reach a decision unanimously (except in the case of a natural disaster). The agreement on a Stability and Growth Pact will ensure a far more stringent monitoring of economic policies, as will be discussed further later in this paper. On the whole, therefore, the risks of regional generosity inside Europe that could be seen as a threat to IMF conditionality have proved to be limited and they should be largely eliminated after 1999, consistent with the so-called “no-bailout” provision in Article 104 of the Treaty.

Finally, Polak raised the question whether the ECU was likely to become a global competitor to the SDR. The comprehensive survey by Eichengreen and Frankel (1996) confirms that the SDR’s prospects as the principal international asset remain unpromising, but that the main reasons for this are to be found in the rapid growth of currency assets and increasing capital mobility (though the net impact of this factor was found to be ambiguous) rather than in the emergence of the ECU as a competitor to the SDR. The ECU has not in itself been very successful in private financial markets or as an international reserve asset for non-EU-holders. There has certainly been little promotion of the ECU in these roles by European governments. Indeed, the word “promotion” was carefully shunned in the Maastricht Treaty in describing the role of the EMI in the relation to the unit—it was confined to simple “monitoring” and the original ambition of actively fostering the ECU as a reserve asset, very evident in the 1978–79 documents establishing the EMS, was watered down.

In summary, the concerns that appeared legitimate from an IMF perspective in the early stages of the EMS have not materialized in the way foreseen by Polak. There was simply not the will in Europe to engage in substantial regional competition with key activities of the IMF; the European efforts took a different direction, with the main feature being convergence based on rules. Despite this verdict, the global institutions and, in particular, the Fund would be justified in looking back at the long period since the start of the EMS with some disappointment. The preoccupation by the Europeans with their internal unification process has absorbed European official attention to a degree that has not facilitated participation in global forums and initiatives. Advice from the Fund and other outsiders has not been encouraged or well received, given the sensitive nature of Europe’s regional integration. And, finally, the Europeans have not yet succeeded in making their external representation more efficient, though this has been one of the aims of the process. The next section of this paper turns to this issue.

Multilateral Surveillance and EMU Representation in the Fund

Turning to the future organization of multilateral surveillance of EMU countries after Stage III has started, and to the closely related issue of the representation of EMU participants in the Fund, it is useful to start from past trends in surveillance within the EU and in the Fund.

Two such trends stand out as both important and likely to continue into Stage III in accentuated form: (1) the highly asymmetric nature of the pooling of authority with full centralization of monetary policy and continuing decentralized national budgetary policies; and (2) the deepening nature of what may most appropriately be labeled country-specific surveillance in the EU. Both trends already complicate the participation of EU countries in Fund multilateral surveillance, and the potential conflicts may sharpen after 1999. On the other hand it could also be argued that Fund surveillance of EMU members could be regarded as a useful complement to internal EMU procedures.

Multilateral surveillance in the sense that it has developed in the Fund over the past two decades hardly existed in the EU some years ago (see Andersen and Thomsen, 1996). Monetary policy was guided by the rule book of the narrow-margins EMS, and other policies were rarely subjected to explicit monitoring by the ECOFIN Council. There were two exceptions to the latter: (1) countries that had borrowed for medium-term external adjustment (Greece and Italy) were subjected to more intensive monitoring, but such cases were rare; and (2) realignments prompted more intensive discussion about the appropriate balance between devaluation and domestic adjustment. But realignments did become rarer and smaller after 1983, and when they resurfaced in 1992 there was no time to design balanced policy packages. Nor was the simple linkage made that countries that had devalued very substantially should be expected to be able to make more rapid budgetary consolidation.

All of this underpins the general impression that macroeconomic policymaking in the EU has not lent itself to multilateral surveillance of the type favored by the Fund—and that future developments in the transition to EMU could make the difficulties worse. The essence of multilateral surveillance is to exchange views on the appropriateness of the policy mix in individual countries in the hope of modifying it in a direction helpful to international adjustment. Sometimes that effort is difficult for large members, in which both monetary and budgetary policies are centralized, but the policy mix appears locked into an undesirable combination for a long period. U.S. policies in the first half of the 1980s and German policies following unification are recent important examples. The fact that the national authorities have policy instruments available in both the monetary and the budgetary area offers no assurance of a productive dialogue between the authorities or with outsiders.

Despite these caveats about international discussions of the policy mix in the past, it must be admitted that the design of EMU will give rise to additional complications. With monetary authority centralized in the ECB and the aggregate fiscal stance emerging primarily from the decisions of national governments and parliaments (in relation to which the—restricted—ECOFIN Council will only have the authority to monitor and sanction “excessive deficits”), discussions focusing on the policy mix will be as handicapped internally as they are in global forums such as the IMF or the Group of Seven industrial countries. It may of course be hoped that the constraints on deviant national behavior imposed by the Stability and Growth Pact will contribute to an acceptable policy mix and avoid the type of imbalances familiar in the United States and Germany (among other examples) in the past, but for the EU to attain a policy mix that will be regarded as satisfactory and beyond discussion by outsiders is only likely to happen by accident. The criticism could go in either direction: either that the sum of cautious national fiscal policies in combination with the expected tough monetary policy of the ECB will produce effects that are considered deflationary in the aggregate by outsiders—this is the current U.S. attitude to policies in the run-up to EMU—or that the sum of national fiscal policies, all or most hovering just below the reference value of 3 percent and hence difficult to correct for the EU, could be regarded as distorting the policy mix and inflicting high interest rates on the outside world.

Whatever the outcome is, it will be difficult to modify through a process of multilateral surveillance in the Fund or any non-EU body. The ECB will be very defensive, at least initially, of its own evaluation of what is required to best meet its mandate of pursuing medium-term price stability as a primary objective, though the ECB may be open to the kind of technical advice on how to implement chosen targets that the Fund staff is particularly well equipped to give. As to national governments, they will want to use as fully as possible the room for maneuver available under the guidelines set by the Stability and Growth Pact. They should welcome any advice on how to operate inside these constraints. And the more national governments insist—correctly—on the fact that they have retained their budgetary powers even in EMU, the stronger are the formal grounds for continuing to subject them to multilateral surveillance in the Fund.

Macroeconomic policy formulation in EMU can only be called indirectly cooperative. In both the monetary and the budgetary areas, the framers of the Treaty and of the supplementary steps taken since Maastricht have adopted a view of policymaking inspired by public choice. Policies will to a large extent be rule bound, with limited room for discretion and justification for deviations due to national circumstances. The monitoring of policies will then center on how well the ECB or national budgetary authorities perform relative to the targets preset for them and will depend hardly at all on whether the targets remain appropriate at all times. In particular, the Stability and Growth Pact, with its elaborate procedures and ultimate threats of sanctions, constrains potentially deviant national behavior by committing participants to guidelines for public debt dynamics designed to assure financial markets that public finances will remain sustainable. Just as the selection of participants for Stage III is in part a process of persuading financial markets that this or that country is becoming ready to participate, so the rule book for subsequent behavior is designed to provide markets with easy references so that they can impose their disciplinary measures in the form of higher credit spreads on a government early in a deviant path. In either case, it is an exercise in which outside advice in a multilateral surveillance process will not necessarily be welcome, even if it is discreet—that is, if it remains unpublished, as is currently the practice with Fund advice.

One further observation again underlines the difference between the ways in which policies will have to be monitored for a large Fund member on the one hand, say, the United States or Japan, and for the group of EMU participants on the other hand. The latter will have no well-developed position on what its aggregate stance should be. The aim of an appropriate aggregate performance in EMU may become lost during the process of detailed country-by-country monitoring. Imbalances on the collective current account balance of the EMU participants may turn out to be a factor that triggers policy adjustment in the ECB’s stance, in the modification of long-drawn-up convergence programs of individual participants, or in both. But this is far from certain—indeed, it looks unlikely. The rest of the Fund constituency will, however, be keenly interested in finding out what the scope is for modifying any “benign neglect” on the part of EMU toward its external position.

Other Fund members will be particularly anxious through multilateral surveillance and Article IV consultations to discover the attitude of the ECB to ad hoc efforts of coordinated intervention of the type seen in the 1980s in the Plaza Accord and Louvre Agreement, as well as in more recent periods. But they are unlikely to discover more than can be extracted by careful reading of the verbose Article 109 on exchange rate policy in EMU, namely, that the ECB will be in charge of the external value of the euro, except in the highly unlikely circumstances of a “formal agreement” within the IMF, adopted unanimously by EMU governments, to reconstitute a fixed-but-adjustable exchange rate system. Multilateral surveillance of EMU would have to be two dimensional, exploring both the congenital reluctance of the ECB to undertake commitments in the exchange markets and the likely aim of the finance ministers to minimize misalignments. This has implications for the representation of the EMU countries, to which we return below.

Some years ago, prior to the entry into force of the Maastricht Treaty, it could safely be said that the Fund had developed the procedure for multilateral surveillance further than had the EU countries. Indeed, it was often said during and after the Maastricht negotiations that the EU countries needed to catch up with practices with which they were supposedly familiar at the global level. They may now appear to have done so, according to the experience over the past three years of applying the provisions of Articles 103 on surveillance and 104c on excessive deficits. Some remarks on this experience, comparing it to Fund practice, may now be appropriate.

Surveillance is conducted by the ECOFIN Council, following preparatory work in the Monetary Committee (after January 1, 1999, the Monetary and Finance Committee), the Economic Policy Committee, and—whenever it becomes fully functional—the Labor and Employment Committee.8 The EC prepares the material and the draft of the broad policy guidelines, which form the basis for surveillance in Article 103. These guidelines refer to both macro-economic and structural issues, but the balance is different from that of the Fund, with more emphasis so far on budgetary policy, and less on structural problems in the labor market. It must be admitted that the EU is still somewhat behind what has been done by the Fund and, in particular, by the OECD through its massive Jobs Study, to analyze structural impediments to higher employment. This imbalance may be partly rectified before Stage III starts, given the alarming present level of unemployment, but the emphasis will remain different. While the Europeans will continue focusing on what might be done by cutting indirect wage costs, for example, shifting taxation to forms less unfriendly to employment, and by improving training, the focus in Fund surveillance will no doubt remain on more general measures to improve labor market flexibility. This difference in emphasis is explained by the (Continental) European preference for a high level of social protection, but it is healthy to challenge this preference with a more global perspective. It should be recalled that the EMU participants have retained full authority over their labor market and other structural policies, so there is no question as to the recipient of any recommendation arising from Fund surveillance.

Article 104c is specifically tailored to monitoring compliance first with the convergence criteria and after January 1, 1999, with the Stability and Growth Pact. Since inflation and long-term interest rates will then have converged and internal exchange rates will have been frozen, this special type of surveillance will be oriented specifically toward the monitoring of the deficit and debt ratios of participants in Stage III. The legal text on which this second type of surveillance is to be based will be put on the agenda of the European Council meeting in Amsterdam in June 1997, but the principles are already clear. The ECOFIN Council will follow, over the period after a transgression of the reference value of a 3 percent public sector deficit, a policy of graduated sanctions: confidential recommendation, public recommendation, warnings attached to new bond issues by the country concerned, restrictions on lending by the European Investment Bank, and, ultimately, the imposition of deposits into an interest-free account, which after two years without any correction of the policy would be converted into a fine. A schedule for the latter two sanctions has been agreed, which should constitute a powerful deterrent to transgressions of the ceiling for the deficit ratio. But graduated sanctions should begin to bite well before these ultimate steps are taken, not least because of the publicity that will be given to some of the early steps.

There is nothing comparable in the Fund surveillance procedures to the excessive deficit procedure in EMU. National budgetary policies will be monitored more regularly, at a higher political level—ECOFIN Council versus the IMF Executive Board—and the whole process is to be carried out under the scrutiny of the general public and, in particular, financial markets, which have been assigned some of the unpleasant work for the governments. This contrasts strongly with Fund practice, which is to address confidential recommendations to a member government. These recommendations may well be more detailed, even with respect to budgetary policy, than those of the ECOFIN Council and they will cover a wider range of structural issues. They are still likely to carry less weight than the highly focused excessive deficit procedure.

Does the impression that EU surveillance, despite its narrow focus, appears to have finally overtaken Fund surveillance in importance imply that the latter is losing its usefulness and relevance and that it should be organized differently once Stage III of EMU starts? That does not follow. Fund surveillance will be a useful supplement, precisely because it is broader in scope, confronts EMU Fund members with a wider and still highly relevant policy experience throughout the world, and is not tied to the very special features of the Maastricht Treaty with its convergence criteria and Stability and Growth Pact. Although the Fund staff may still need to be cautious about any outright element of criticism of these European features, once EMU has started the whole construction will become more robust and less sensitive to outsider criticism than has been the case during the transition. Finally, there are no formal grounds for keeping surveillance of national budgetary policies strictly within the EMU family. EMU countries cannot expect or claim, while retaining their authority over national budgets, to have different status in this area from other Fund members.

Nor is there any obvious need for involving EMU institutions or bodies other than the national governments and—for some purposes—the ECB. The Commission has no particular authority in either the monetary or other economic policy areas that requires it to be formally involved in consultations, but its important role in organizing surveillance in EMU would make regular contacts between the two staffs desirable. The ECOFIN Council has neither a president nor a secretariat that could add to the information provided by national governments, except possibly on the formulation of the “general orientations for exchange rate policy” on occasions when the Council has used its capacity to formulate such orientations in Article 109.2.9

The only difficult issue seems to be how to involve the ECB, without which an important voice would be missing in most discussions on multilateral surveillance. Since the ECB cannot become a member of the Fund, some ad hoc solution will have to be found to allow the ECB to be present at discussions in the IMF Executive Board—obviously, as an observer—when exchange rate issues and other major policy questions arising from EMU are on the agenda. Much of the IMF’s agenda is clearly of limited interest to the ECB, but both sides would lose if it were left to EMU member governments assisted by representatives of their central banks, which would by then be organic parts of the ESCB, to be the sole EMU representatives in Fund discussions of surveillance. The ECB might be encouraged to establish an office at the Fund for smooth coordination when a presence in the Executive Board is warranted.

As long as the EMU countries show no indication of giving up their national budgetary authority, the only realistic solution is to let the Fund member states that are also in EMU continue to be represented by their national governments directly or through the shared constituencies in which they currently operate, while admitting the ECB on an ad hoc basis and conducting Article IV consultations with the ECB.

“Fringe” Arrangements Surrounding EMU

If it is reasonably clear that EMU participants should continue to be subject to Fund multilateral surveillance in areas for which they remain individually responsible in Stage III, it follows that this would also apply to EU countries that have not joined Stage III because they have failed to meet the convergence criteria with a sufficient degree of approximation or have been granted the right to opt out, as is the case for Denmark and the United Kingdom. These countries will obviously have retained authority in both the monetary and the budgetary areas, even though some of them will feel severely constrained in their policy choices, particularly if they have narrowly missed entry into Stage III and aim to make the additional transition as short as possible.

The IMF, in view of its wide experience in monitoring exchange rate policies throughout the world, will have something to say on the exchange rate relationships between the euro area and nonparticipating European currencies. The experience in 1992–93 underlined the vulnerability of a narrow-margins arrangement comprising currencies for which convergence was still suspect. On the other hand, the experience of Austria over two decades and of the Netherlands over one shows that narrow margins are perfectly feasible once convergence is advanced and the smaller country is seen to mimic the monetary policy of the anchor country. Despite the long record of successful achievements of the EMS prior to 1992, EU official opinion has now moved against the resurrection of a tight arrangement with the euro for those who do not make it into EMU. The earlier vision, when EMU was conceived in the late 1980s, of monetary unification proceeding through a funnel-like process of narrowing margins today has few, if any, advocates. Wide margins have worked rather well for those who remained in any system and the inclination is currently to rely on them in ERM II in Stage III. This is also seen to have the virtue of placing the overwhelming part of the responsibility for stabilizing a currency on the issuer rather than on its partners; wide-ranging intervention commitments are seen as dangerous by some and as unreliable by others—not surprisingly, following the collapse of commitments in 1992.

The question is whether the pendulum has swung too far. Must the transition from a system with some flexibility to full EMU be quite as dramatic as it now appears? If a group of countries that obviously places a high value on exchange rate stability is not prepared to assist those who aspire to join by offering them potentially considerable intervention support, future entry into EMU may become even more difficult than it will have been for the first group. This question is relevant for 1999 if some candidates fail entry with a small margin, because the ERM II that is on offer sounds as if it is devised more for countries far from converging to EMU standards than for countries that have been engaged in convergence efforts over a number of years.

The way in which the ERM II is finally set up is watched with particular attention by the Central and East European countries most likely to join the EU sometime over the next five to eight years. It is improbable that any of them would be in a position to also join EMU right away; their inflation performance, in particular, seems bound to fall short of the requirements for some time. But in each of the prospective member states, the issue of when it would be most appropriate to supplement the domestic efforts to get closer to price stability by firming up any anchoring to the euro will arise as soon as membership is on the horizon. For this group at least, a graduated phasing into EMU will remain on the agenda and the Fund’s surveillance of their efforts will be of great importance.

For a couple of EU countries—the United Kingdom and Sweden—which had unhappy and brief links to other European currencies, the preference today is to stay outside EMU for the time being and to reject participation in ERM II as well. These two countries both opted for inflation targets as the basic framework for their monetary policy just after the dramatic foreign exchange crises of 1992, and this has served them well. But the question remains whether purely domestic targets—and one has seen in the recent movements of sterling that they are purely domestic—can deliver anything close to the degree of nominal exchange rate stability that the single market requires for its smooth functioning. This, too, is an area in which Fund surveillance will be valuable.

Finally, there is the interesting aspect that the nonparticipants will not be subject to the same discipline as those already in the euro area. When the Maastricht Treaty was drafted, the main temptation of a relapse into laxer policies was seen to present itself to countries that had joined and were then free of the constraints arising from foreign exchange crises and higher domestic interest rates. Those outside were expected to aspire to early entry and hence to be on their best behavior; they were accordingly not to have sanctions imposed on them. Even though the role of sanctions should not be exaggerated, the absence of both sanctions and any short-term need to perform according to the convergence criteria may create incentives for competitive and divergent behaviour, which should be closely watched by the EMU participants and in the Fund's multilateral surveillance.

In short, the “fringe” arrangements surrounding EMU—how best to prepare additional countries for participation, the adequacy of national inflation targeting, and the monitoring without sanctions of the nonparticipants—offer a wide and fertile ground for IMF surveillance. Monitoring of nonparticipants will clearly be more sought after than that of the EMU participants themselves, because there will be less self-assurance among the nonparticipants and they will welcome a second opinion on their options rather than relying solely on the views of the EMU participants.


The subject of the conference is speculative, because there is as yet no certainty as to how EMU will operate, or as to who will initially participate. To try to analyze the future relations between the Fund and the EMU participants is therefore doubly hazardous. This paper therefore starts from the present situation and addresses some IMF concerns that have been expressed in the past as to the potential fragmentation of the global monetary system implied by the emergence of a greatly reinforced regional integration in the EU.

The tasks of the Fund in the transition to EMU have required tact because of the great sensitivity of the Europeans vis-à-vis criticism of their de facto increasingly joint monetary policy, which did not fully incorporate both the economic and the political momentum behind integration. However, Fund surveillance of budgetary and structural policies in the EU member states has been thoroughly welcome.

Early IMF concerns about fragmentation of the global system if European integration proceeded to a more institutional stage do not on the whole appear to have been borne out. European monetary integration has not boosted international liquidity or introduced significant elements of soft lending inside the region. The ECU did prove to be a competitor to the SDR, but the SDR’s relative stagnation primarily reflects factors other than European integration.

Turning to the core of the paper, some comparisons are made between the surveillance practiced in the Fund and the monitoring of policies in the EU, which has only been intensified relatively recently. The main weakness of EU monitoring is that it is ill equipped to address issues of improper policy mix, because the arrangements to keep centralized monetary policy with budgetary policies as a national responsibility hamper any dialogue on this subject. Furthermore, EU monitoring takes place on the basis of an elaborate rule book that focuses on how countries perform relative to the rules, be they of monetary coordination or of constraints on national budgetary policies. Precisely for this reason, Fund surveillance should be welcome, because of its likely attention to aggregate performance in the euro area.

On the institutional side, the only truly new development is the emergence of the ECB, whose presence in the IMF Executive Board when multilateral surveillance of macroeconomic policies in the EU is discussed seems very useful. Some ad hoc arrangement is clearly called for.

As long as national EU governments insist that all nonmonetary policies remain a national responsibility even in EMU, they can hardly object to continued Fund surveillance of their policies individually. This also applies to nonparticipants in EMU, for whom also monetary policy will remain to some extent national. The “fringe” arrangements surrounding EM—ERM II and the monitoring of exchange rates of EU countries not in ERM II and of macro-economic policies of the outsiders more generally—should remain fertile ground for IMF surveillance.

Some officials have recently been more explicit; see in particular Maystadt’s speech in this volume for a number of operational proposals.

See, among others, Delors Report (1989), para. 57. It was recognized all along that ultimate monetary authority would remain in national hands right up to the start of Stage III.

IMF(1996), p. 43.

For an evaluation of why the EMF project failed to take off, see Gros and Thygesen (1997), Chapter 2.

Eichengreen and Frankel (1996) present a thorough survey of the evolution of reserves.

Prior to January 1, 1994, the; European Monetary Cooperation Fund, better known by its French acronym FECOM.

This Committee, composed of representatives of treasuries and ministries of labor, is an outgrowth of the growing concern about employment to the EU, more specifically of the so-called Essen Initiative of December 1994.

For a fuller discussion with a different conclusion, foreseeing in particular Fund contact with the Economic and Financial Committee, see the paper by Polak and speech by Maystadt, both in this volume.


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