Year XXVII, 1985, Number 3, Page 195
TOWARDS A FEDERAL EUROPEAN ECONOMY: PRE-FEDERAL MONETARY UNION*
No in-depth analysis of the monetary organisation of a federal state has yet been made so that no clear definition can be given for the institutions and mechanisms needed to provide the European Union with the powers it needs in monetary matters.
On the other hand, knowledge and thinking about fiscal and budgetary policy has reached a much more advanced stage, so much so that the term “fiscal federalism” is currently used. Analysis of how it works within existing federations, especially the United States and Federal Germany, is of great significance when defining the areas were the European Union should have fiscal powers.
Monetary organisation in existing federal states
“Monetary federalism”, unlike fiscal federalism, is still a theory in an embryonic stage and this is undoubtedly due to the fact that there is no substantial difference between the monetary organisation of existing federal states and that of non-federal states. Indeed, whereas there is competition, albeit in different degrees, between the jurisdiction of the federal government and that of the member states of the federation as regards fiscal matters, with money matters this jurisdiction is solely a federal concern.
In the United States, the Federal Republic of Germany and Switzerland there is a single currency, the issue of which is the monopoly of a single central bank, just as in non-federal states, but the central bank has a special structure and even its name contains a reference to federalism (Deutsche Bundesbank and Federal Reserve System). In Germany the federal central bank is flanked by the central banks of the Länder. These, however, have no authority at all with regard to the issue of money, but merely a right of representation on the decision-making body of the federal bank, where the local representatives actually constitute the majority.
In Switzerland, the position is much the same as in Germany, while the American system displays fewer federal features, since the twelve districts of the Federal Reserve System have no institutional relationships with the member states of the American federation.
There is, however, one feature that characterises the monetary organisation of these three federal states, namely the powerful autonomy of the central bank vis-à-vis state institutions (government and parliament), which means that the bank is somewhat similar to a “federal court”. In the German and Swiss cases, this autonomy stems from the predominance of the Länder and Cantons in the central bank’s decision-making body, whereas in the US the bank’s autonomy vis-à-vis the government is safeguarded by the “private” features of the 12 districts and the long-term tenureship of office by the members of the Federal Reserve Board, the supreme body in the system.
Attempts at monetary unification in Europe.
In my view, this situation explains why all attempts to achieve monetary unification in Europe following the creation of the European Community were based, firstly, on the idea of one currency, or several currencies closely knit to each other by a fixed exchange rate, and secondly, the idea of strong centralisation of monetary power.
Formal adoption of the Werner Plan and launching of his first stage and the institution of the European Monetary Co-operation Fund were not enough to reach these objectives. Not only were the subsequent steps – expressly envisaged in the resolutions – left unimplemented, the system itself suffered the “secession” of so many states that, de facto, it disappeared.
When the European Monetary System was launched in December 1978, a more flexible approach was adopted, since the system was based on “fixed but adjustable” exchange rates. In the case of the EMS, an important point was the adoption of the ECU as the system’s benchmark. Indeed, fluctuations in the national currencies are referred to this unit and deposits held by the national central banks with the European Monetary Co-operation Fund in return for 20% of their own gold holdings and dollar reserves are also stated in this currency.
For the second stage the EMS envisaged maintaining the possibility of varying the exchange rate of individual national currencies against the ECU (and hence against other national currencies). Its main feature was the creation of an institution – the “European Monetary Fund” – designed to carry out certain tasks in the management of common reserves and the granting of credits (as foreseen by the System) to the national central banks.
A European pre-federal monetary union.
Europe must establish an appropriate common monetary organisation if it wishes to maintain the customs union and the common agricultural policy. The need is all the greater since it is designed to set up a “domestic market” and tackle the problems raised by restoring growth, changes in international economic relations and the challenge of scientific and technological evolution.
We can define this objective as the establishment of a European pre-federal monetary system designed to achieve two fundamental objectives: a) full convertibility of the Community currencies; b) “stability” of exchange rates so permitting the economic calculations needed to guarantee the operation of the “domestic market” and above all prevent recourse to changes in monetary parities which penalise enterprises of other countries.
By analogy with what happens for a customs union, the real difficulty is to see that these two conditions are insulated so as to protect them from the designs of the member states. In the same way as the Treaty setting up the European Community lays down that customs duties cannot be reintroduced and entrusts a common institution (“the Commission”) with the task of seeing that this “irreversible” commitment is complied with, so, too, it is necessary in the monetary field for the convertibility of currencies and the “stability” of rates of exchange to be safeguarded by a common institution preventing unilateral action by states destined to undermine the commitments undertaken.
The true difficulty with a customs union is not the removal of duties but the prevention of their reintroduction by a member state in moments of crisis and difficulty, possibly in a “disguised” form. Much the same is true in the monetary field: preventing a state from nullifying the convertibility of its currency during a crisis or resorting to “competitive” devaluations. Only the presence of a common monetary institution empowered to ensure that these two conditions are maintained and equipped with the means to overcome the crisis will ensure this objective is attained.
Basic features of the pre-federal monetary union.
Convertibility of a currency means that those resident in different parts of the Union can freely exchange assets in their national currency for the currencies of the other states, or at least into the common currency of the Union.
The common monetary institution must thus ensure: permanent convertibility of one national currency into another and into the common currency; that changes in the rate of exchange between a national currency and the common currency do not disturb the “domestic market”. It must thus have the ability to intervene on the market to assure that convertibility is possible at all times and decide on changes in exchange rates.
This, however, is not possible unless the institution: controls the amount of “common currency” issued; guarantees the value of the common currency outside the area (policy vis-à-vis currencies outside the area); and “conditions” the credit granted to national central banks experiencing difficulties in keeping up the convertibility of their own money into the common currency. Even if this analysis requires much further study, a sufficiently clear picture emerges of the tasks that will have to be assigned to the “European Monetary Fund” if the EMS is really to become the monetary tool by which Europe is assured of the existence of a domestic market for agricultural and industrial products.
The EMS and the ECU.
The establishment of the European Monetary System was really designed to deal only with the question of the rate of exchange. No solution at all has been found for the problem of the convertibility of individual national currencies, since Europeans resident in many member states cannot freely exchange their money into another currency circulating in other countries.
The need for full convertibility of European currencies – or better still the existence of a common currency – came to the fore in the early years of the EMS’s operation, while the appearance of the ECU through the efforts of the operators has clearly highlighted the contradictions existing between a single market for agricultural produce and industrial products and the existence of separate financial markets.
The ECU has gradually acquired the classic function of money: a store of value (bonds and deposits have been denominated in ECU); a unit of account (balance sheets, invoices and contracts are denominated in ECU); a means of settlements (payment orders, cheques, travellers’ cheques, etc.).
The member states of the Community have thus been forced to take a series of steps towards the convertibility of their national currencies, at least into the common European currency.
From the institutional standpoint, the EMS did not bring new institutions into being, but confined itself to revitalising those which already existed since they were created during attempts at unification and which had remained virtually inactive.
The European Monetary Co-operation Fund, for example, has acquired the authority to determine changes in the rates of exchange between national currencies and the ECU, as well as the composition of the ECU itself. The binding approval of the Fund, in fact, is needed for the issue of the necessary regulation by the Council of Ministers of the European Community.
The wide-scale use of the ECU by private operators has brought about measures designed to prevent the central banks from being excluded from its control.
The agreements reached in Palermo last April gave the official ECU issued by the Fund greater liquidity so as to restore its competitiveness as compared with the ECU issued by private banks. Provision was also made for circulation of the official ECU outside the European Community. Subject to certain provisions, this can now be held by other central banks and international monetary institutions, especially the Bank for International Settlements (BIS).
Establishment of a clearing system for private transactions with the BIS as agent will allow the management of the ECU to be taken out of the hands of the so-called “Euromarket”, thus laying the foundations for ensuring the liquidity of this currency, and in addition, the stability of the banking system.
Measures to be adopted.
In recent years, the European Monetary Cooperation Fund has acquired the beginnings of an authority which could be further expanded, with regard to: charges in exchange rates; management of ECU assets (directly for the “official” ECU, and indirectly for the “private” ECU) , though it has not yet received any mandate to act as “guarantor” of European citizens’ freedom to convert their currency without restrictions.
Further expansion of ECU-denominated assets (both private and official) will require the Fund to exercise its stabilising function more frequently. In particular, it will have to take decisions in the light of “European” rather than national initiatives. In other words, an international ECU market of considerable size will not always be able to “comply” with national initiatives without prejudicing both the value and the stability of the ECU itself.
Developments on the main international marketplaces (especially New York and Tokyo) of transactions (both spot and forward) between the ECU, dollar and yen may soon create a problem over Europe’s financial “credibility” and this in turn will affect its individual national currencies.
Europe will be able to make use of a monetary organisation on a par with that reached by economic interpenetration when provisions are adopted within the EMS to: give citizens the freedom to choose between their national currency and the ECU; give the Fund sufficient ability to take initiatives, and lay down that in certain cases a majority vote will be sufficient to take decisions relating to the value of the ECU and its circulation.
These are limited, yet indispensable, objectives that must accompany the creation of the European Union in the monetary field.
Can “monetary federalism” exist?
The functions attributed to the European Monetary Co-operation Fund in this scheme are substantially in line with the indications given by James Meade for his “supranational exchange equalisation system”, in which provision is made for action by a “supranational equalisation authority” to ensure control of short-term fluctuations, together with retention of the possibility of altering the exchange rates to maintain long-term equilibrium in balance of payments.
The fundamental idea, however, harks back to Lionel Robbins’ suggestion – made half a century ago – for an “international currency”. His attribution to a federal monetary authority of the power to vary the exchange rate of individual currencies vis-à-vis the common currency, perhaps gave us a solution to the difficult problem of making the EMS stable.
It is hard, on the other hand, to answer the question whether in the light of Robbins’ suggestions there exists a “federalist” solution also in the monetary field with a division of powers between federation and state (and possibly on lower levels), or whether the only way to achieve efficient currency organisation is to issue a single currency sign; here the only “federalist” feature would be the special structure of the central hank, as in the German case.
But asking whether federalism can make an original contribution in the monetary field is no longer an idle question. The struggle to provide Europe with a common currency requires that at least the federalists be capable of reflecting on these topics without being hidebound by the monetary organisation model that has characterised centralised national states.
*Speech delivered in Canterbury, at the UEF seminar on September 14, 1985.
Some additional remarks on this subject are presented in “L’autonomia della banca centrale in Italia e in Europa” by A. Jozzo and D. Velo, in Moneta e Credito, June 1981.
Employment of the term “pre-federal monetary union” can be justified by analogy with the proposals in the MacDougall Report (Report of the study group on the role of public finance in European integration), April 1977.
“The various forms of exchange-rate flexibility” by James Meade, in International Payments Problems, Washington D.C., 1966.
“Economic problems of the Federation” by Lionel Robbins in Federal Union, 1941.