The future of the euro: a public choice approach.

• Author: Vaubel, Roland

The future of the euro will not be like its past. The institutions, the rules, and the persons governing the European Monetary Union have been selected in a very special historical setting. They are not resistent to change, and they will adapt to normal conditions.

The overture to the euro game has been very special because initially one country--Germany--enjoyed veto power. Without German assent, the EMU would not have started. Moreover, Germany had most to lose, or least to gain, from the EMU because its central bank had won a position of monetary dominance in Europe. It is true that in December 1989 the German government under Chancellor Helmut Kohl had committed itself to the EMU in principle--in exchange for French assent to German reunification. But the implementation of that promise was a matter of choice and negotiation up to the very end in the second quarter of 1998. The German government was the driving force behind the statute, notably the independence of the European Central Bank; it imposed the Stability and Growth Pact on its reluctant partners; it delayed the redistribution of seigniorage which is at Germany's expense; it carefully screened the candidates for the Executive Board (including the president); and it made sure that the Economic Directorate would go to a German monetary conservative with a maximum term of office. Even though 7 of the 11 participating states had socialist-led governments in 1998, only 1 of the 6 executive directors had a socialist background, and even he, President Wim Duisenberg, was known to be a monetary conservative. This choice was not an attempt to correct for time inconsistency by appointing conservative central bankers a la Rogoff (1985) but the result of the German veto position.

Once the EMU had started, the German veto was gone. The participating countries cannot even leave the EMU without leaving the European Union (EU) altogether. Appointments and policies are no longer determined by the most inflation-averse member country (as under currency competition) but by the median. The effects are already visible. They are the beginning of a shift away from initial conditions and toward the long-run politico-economic equilibrium of the game.

Decisionmaking

As in 1998, the executive directors have to be appointed unanimously. (1) But now the EMU would also persist without the appointment of new executive directors. In the extreme case, the ECB could be run by a Governing Council exclusively composed of the national central bank governors. This means that the government which most closely shares the inflation preferences of the median national central bank governor will have the strongest bargaining power. I have shown elsewhere (Vaubel 2003a: Tables 6.1 and 6.2) that, in terms of both past inflation experience (1976-93) and popular preferences as revealed in opinion surveys, the median position among the national central bank governors has been held, with a short interruption in 2002-03, (2) by the two French members. Unlike in 1998, the German representatives are marginalized. If the two medians did not coincide, public choice theory would predict that, gradually, monetary conservatives on the Executive Board would be replaced by more inflation-prone central bankers until the median of the Governing Council is the same as the median among the central bank governors.

An extremely important change of personnel will be the retirement of the German executive director in charge of economic affairs in May 2006. I expect that his successor at the Economic Directorate will not be a German and that the new German executive director will be nominated by the current left-wing government of Germany.

The constitutional convention chaired by Valery Giscard d'Estaing has proposed that various decisions about the instruments of monetary policy and the distribution of seigniorage should no longer be taken unanimously but by qualified majority (Article 107, section 5 TEU in the version of Nizza). This would enable a majority of member states to raise the cost of minimum bank reserves at the expense of the minority of member states that host the main financial centers.

The Commission proposed in November 2003 that the European Council should be empowered to amend important parts of the ECB statute (Articles 10 to 12 and 43), acting unanimously and on a recommendation of the Commission, but without the assent of the ECB, without an intergovernmental conference and without any parliamentary control. This would enable the European Council, for example, to redefine price stability (Article 12) or to dismiss individual members of the ECB Council on charges of misconduct (Article 11.4).

Money and Inflation

In 1991, the member states agreed that price stability should be the primary objective of ECB monetary policy. But, unfortunately, the Treaty does not say what price stability means. So price stability had to be defined by the Governing Council of the ECB. Its initial definition was an inflation rate between 0 and 2 percent. The ECB Council did not announce money supply targets. This was to be expected from public choice theory. After all, only 1 of the 11 central banks (the Bundesbank) had done so in the recent past. Moreover, it is easier to agree on an inflation target and leave open how it may be attained. If it is not attained, this might be attributed to factors other than monetary policy. Failure to attain it will not be sanctioned.

Nevertheless, initially and, at German insistence, the Governing Council adopted a "reference rate for monetary expansion" of 4.5 percent (M3) as its primary indicator for...