The Challenges of the European Economic and Monetary Union

At the dawn of the newly implemented Eurozone, Lorenzo Bini Smaghi and Daniel Gros argued that three broad issues might present problems for Europe’s Economic and Monetary Union (EMU). In their 2000 book, Open Issues in European Central Banking, Bini Smaghi, then Director for International Affairs at the Italian Treasury, and Gros, then Deputy Director and Senior Research Fellow at the Brussels-based Centre for European Policy Studies and Head of its Economic Policy Programme, outlined the challenges of allocating monetary tasks between member states’ National Central Banks (NCBs) and the supranational European Central Bank (ECB), the unclear prioritization of monetary and financial concerns, and the tension between independence and accountability. Despite their caution, the authors remained optimistic that the beginning of Europe’s EMU was an opportunity for greater financial and monetary cooperation within the region and development across the Eurozone. However, two recent crises in the Eurozone have confronted Bini Smaghi and Gros’s predicted challenges and resulted in dramatically different responses.

Allocation of Monetary Tasks

Bini Smaghi and Gros argued that there was no clear allocation of monetary tasks between NCBs and the ECB. This presented uncertainty for outcomes if central leadership of the ECB objected to NCB decision-making during either routine business or extraordinary circumstances. It also revealed the potential for disagreement between central bank leadership of different member states to hinder nationally focused monetary policies.

Prioritization of Monetary and Financial Concerns

The authors also identified a tension between EMU law being unclear regarding the prioritization of monetary and financial concerns—and, consequently the importance of anti-inflationary policies and exchange rate targeting compared to the resolution of financial crises.

Independence and Accountability

The authors acknowledged the potential tension between the goals of NCBs and the ECB. Would NCBs be held equally accountable for undershooting inflation targets as they might if they failed to contain those targets below mandated levels?

Recent Crises in the Eurozone

In 2008, the ECB initially delegated crisis response to the NCBs, but it overstepped this mandate. As the Eurozone crisis gradually took hold in peripheral members of the EMU, the ECB—citing fears of inflation—intervened to limit NCBs’ abilities to engage extraordinary measures to rescue domestic banks. By contrast, in 2020, the ECB enabled domestic governments and NCBs to respond to the novel challenges of the Covid-19 pandemic through a panoply of measures to increase governments’ spending potential and minimize the cost of government borrowing through different monetary policy measures.

Consequences of Different Approaches

These differing approaches had significant consequences. In 2008, the ECB’s decision to intervene limited the ability of NCBs to respond to the crisis, ultimately leading to a prolonged recession in the Eurozone. In 2020, the ECB’s decision to enable NCBs to engage in extraordinary measures to respond to the pandemic has helped to mitigate the economic fallout of the crisis.

Related Facts

• The European Central Bank was established in 1998.
• The Eurozone consists of 19 member countries.
• The Eurozone crisis began in 2008 and lasted until 2013.
• The Covid-19 pandemic began in 2020.

Key Takeaway

Lorenzo Bini Smaghi and Daniel Gros identified three challenges for Europe’s Economic and Monetary Union (EMU) in their 2000 book, Open Issues in European Central Banking. Two recent crises in the Eurozone have confronted Bini Smaghi and Gros’s predicted challenges—and resulted in dramatically different responses. The ECB’s decision to intervene in 2008 limited the ability of NCBs to respond to the crisis, ultimately leading to a prolonged recession in the Eurozone. In 2020, the ECB’s decision to enable NCBs to engage in extraordinary measures to respond to the pandemic has helped to mitigate the economic fallout of the crisis.

Conclusion

Bini Smaghi and Gros identified the challenges of allocating monetary tasks between NCBs and the ECB, the unclear prioritization of monetary and financial concerns, and the tension between independence and accountability. The ECB’s response to the two crises in the Eurozone has highlighted the importance of addressing these issues to ensure that the Eurozone can respond effectively to future crises.