European Integration, Monetary Co-ordination and the Demand for Money - Tapa dura

Can monetary integration in Europe be improved? The tensions which periodically surfaced within the European Monetary System and which exploded in the 1992-3 Exchange Rate Mechanism crisis do not demonstrate that the thorny issue of the co-ordination of monetary policies is obsolete. Rather, they show the difficulty of identifying and implementing effective schemes of monetary co-ordination. At the heart of this difficulty is the complexity of reaching agreement on the sharing of the cost of macroeconomic adjustment between participants in the system; that is, of finding a solution to the problem of its symmetry. The theoretical and empirical analysis of this book proposes an innovative perspective on the issue of improving monetary integration, written from the privileged viewpoint of central bank experience. After reviewing the ERM experience and the importance of the issue of the system's symmetry in shaping its evolution, the authors identify the economic conditions underlying the choice of the optimal scheme of monetary co-ordination under an exchange rate agreement, and show that one of the key conditions is the stability of the area-wide demand for money relative to the stability of national money demand functions. The analysis then turns to the methodological problems involved in the definition of monetary aggregates for open economics (with special attention to the selection of measures of money for areas comprising several countries), and in the estimation of area-wide money demand equations. On this basis, empirical exploration of the properties of demand for money for the European Union as a whole is carried out by testing several definitions of money and following various approaches, including two - the buffer stock approach and the Currency Equivalent method - which have never been applied to a group of countries. The results show that EU-wide money demand equations are already at least as stable and predictable as the best performing national equations. The empirical findings presented here support the case for the adoption of a scheme of monetary co-ordination which relies on the control of area-wide money supply, and which would employ a mutually beneficial solution to the problem of symmetry.

Carlo Monticelli is the Head of the Exchange Rates and International Finance Section of the Research Department of the Bank of Italy.