After 20 years of monetary unification, can we tell whether the “monetarists” or the “economists” were right?

Conference on:

The Werner Report, 50 Years On.
Economic and Monetary Union in Uncertain Times: Learning from the Past to Navigate the Future

Luxembourg October 7th and 8th.

Parallel session: Tales from crisis
Chair: David Howarth (Professor, University of Luxembourg/Robert Schuman Initiative for European Affairs)

Francesco Papadia Diverging narratives of the euro area – a historical perspective

After 20 years of monetary unification, can we tell whether the “monetarists” or the “economists” were right?

It is a double pleasure to participate to this conference. First, because the topic is so interesting and the roster of speakers so impressive. Second, because it allows me to connect to a similar conference, to which I participated in 1993 ago with Fabrizio Saccomanni, again in Luxembourg, whose proceedings are in a book edited by Alfred Steinherr: 30 Years of European Monetary Integration – From the Werner plan to EMU.

In 1993 monetary union, after the exchange rate crises of 1992 and the widening of exchange margins to 15%, was, while cast in the Maastricht Treaty, definitely not guaranteed. Yet the overall thrust of the con ference, as reflected in the book was that, as planned, 30 years after the Werner report, monetary union would be achieved. As of course we know, that trust proved justified.

In that conference one could find an echo of the long-lasting controversy between so called monetarists and economists. Just to make names, Dyson and Maes[1] identify Triffin as monetarists, with Delors and Padoa-Schioppa also close to that view[2], while Pohl and Tietmeyer are classified as economists. Loukalis referred to this division in his speech. The respective views are well known: economists thought that economic convergence should precede the establishment of the single currency, monetarists believed that a single currency would bring along the necessary degree of convergence. In my understanding, consistently with the view of Padoa-Schioppa and Baer in their review of the Werner plan[3] written for the Delors Report as well as that of Tietmeyer in the Steinherr book, the 1970 plan was closer to the economists view. Indeed, it gave as much importance to a “centre of decision for economic policy” as to a “Community system for the central banks”, which was still a less precise concept than a fully-fledged European Central bank. The controversy between monetarists and economists had a correspondence in academic circles, where the two views took the form of the Optimal Currency Area theory of Mundell, McKinnon and Kenen vs. the endogenous currency area of Rose and Frankel [4].

In the few minutes allotted to me, I want to see whether events in the last two decades help ascertaining whether the economists or the monetarists were right. At the cost of taking any thrill away from my presentation, let me give you immediately my ecumenical, “on one hand – on the other hand” bottom line: monetarists were right on the direction, but wrong on the timing; economists were right over a short horizon, but wrong over a long one.

Before I present to you the reasoning supporting my ecumenical conclusion, a methodological clarification is needed. The original discussion between monetarists and economists concentrated on economic issues: would a single money lead to a synchronization of business cycles, to more intense intra-area trade, possibly to more flexibility in price and wages, validating ex post the decision to move to monetary union? Or would it lead to more sectoral specialization among participating countries that could make idiosyncratic shocks more likely?

The discussions about the incompleteness of the Maastricht design of monetary union has instead moved over the years to prioritize institutional issues. A paramount example of this is the 5 President Report of 2015 stressing the need to achieve a “Genuine Economic Union», a “Financial Union » including Banking and Capital Markets Union, a «Fiscal Union » and, finally, a «Political Union». Each union required institutional innovations.

According to this institutionally based criterion, the assessment of the merit of the economists and the monetarists positions hinges on whether the euro area was ready, from an institutional point of view, for monetary union in 1998 and, much more interestingly, on whether it has progressed enough since.

I think the Great Recession starting in 2007-2008 has dramatically demonstrated that the euro was a fair-weather construction. The economists were right on this. The more difficulty question is whether Europe has sufficiently moved towards the needed institutional setup, following the old Monnetian prophecy of advancing through crises.

I was silly enough 5 years ago, not that I have become much wiser since, to publish a post in  which I proposed a  Monnetomètre[5], a gadget through which to measure in which percentage Monnet`s famous prophecy, that Europe will be built by cumulating the solutions given to recurrent crises, has been confirmed during the Great Recession ». My conclusion then was that 65 percent of the needed innovations had been accomplished. Let me try and run that silly exercise again in the middle of the new, Covid 19 caused, crisis. How much of the “Unions” seen necessary by the five Presidents has been accomplished during, I would say because, of the two crises suffered by the euro?

On financial union, of course we have the critical progress of the single banking supervision, which is generally recognized as functioning effectively, thus filling one important gap left open in Maastricht. On the two other elements of banking union, resolution and, in particular, deposit guarantees, progress has been definitely more hesitant. As regards the other component of financial union, namely capital market union, there is an obvious fact, susceptible of two opposite interpretations. The obvious fact is that the EU has been trying to achieve Capital Market Union for decades, with greater intensity in the last two. The positive interpretation is that this shows the determination to succeed in bringing about a unified capital market. The negative interpretation is that this shows instead the inability to complete the project. We probably have to combine these two different interpretations to come to a sound assessment.

Still on financial union, I believe that, little noticed, we have recently achieved significant progress on the issue of macroprudential policy. The, correct, decision last March of the supervisory wing of the ECB to lower capital ratios just when the risks banks have to deal with has increased can only be understood in a macroprudential framework. This does not mean, however, that we have a fully satisfactory macroprudential framework. First, the ECB decision could only apply to banks, while the non-bank sector escapes macroprudential regulation; second it is easier to take easing than restricting decisions, thus it remains to be seen whether European supervision will be able to tighten capital requirements when needed. Still, even considering these two limitations the progress on macroprudential policy is significant.

On fiscal union, I maintain my not enthusiastic, but still favourable, assessment of the European Stability Mechanism as a tool to address idiosyncratic shocks. Favourable because it indeed helped peripheral Europe to deal with the Great Recession; not enthusiastic essentially because of its intergovernmental rather than EU nature, which led in some important cases to somewhat odd conditionality. I must admit, instead, that my fairly positive interpretation five years ago of the fiscal policy machinery constituted by the Growth and Stability Pact, the various “Packs”, the “European Semester” has changed for the worse. I don’t think that the machinery has been without effect: fiscal policy would have been different, and worse, without this machinery. However, it has not been good enough. I indeed give now a larger negative weight to the strong pro-cyclical tightening of fiscal policy in 2011-2013, just when the euro area was in a very serious recession.

However, my downward revision of the GSP and other fiscal machinery is by far overcompensated by the substantial progress coming from the Next Generation EU fund. I don’t think I have to dwell on this, even the foreign exchange market has recognised the importance of this decision, bringing about a not so welcome appreciation of the euro. The only issue I would like to consider here is whether this innovation is a precedent, raising the possibility of a more active European fiscal policy, or whether it is a one-off event. I think the answer to this question depends on the quality of the public expenses that will be financed by the fund. If these will, as planned, improve employment and growth, reinforce the “economic and social resilience” of the EU and facilitate the green and digital conversion of the European economy, then the decision will be seen as a success and be repeated whenever needed. If the money will be squandered, the frugal opposition to the Fund will rightly say: I told you. The strong steering of national actions set up by the Commission is a good start, but of course provides no assurance in this respect.[6]

The potential impact of the Next Generation EU goes even beyond the fiscal domain, indeed the issuance of 750 billion of EU, AAA bonds would contribute to Capital Market Union, and thus to financial union. Furthermore, it could lead, if properly implemented, to significant progress towards a Genuine Economic Union and I would argue also a Political Union, even if this latter objective looks still very far into the future, with foreign and defense policies still to a very large extent national.

Another important factor, validating the monetarists rather than the economist view, is that the ECB became, during the two crises, a more forceful institution than even the most optimistic observer could imagine when the euro was created. The force with which the ECB has reacted to the Great Recession and is now reacting to the Covid 19 crisis has not only assured the survival of the euro but has also attenuated the negative consequences of these two crises on the European economy and, more broadly, on European society. However, this has not been without negative side effects, in particular the overburdening of monetary policy. Still the growing role of the ECB is in line with the monetarists view that creating the currency will bring along the factors of its success. In a way it is not surprising that a federal institution, with an effective governance system, a clear objective and powerful tools would deliver satisfactorily. The comparison with the performance of the Council of Ministers, deprived of these characteristics, is, symmetrically, not surprising.

In conclusion, consistently with the monetarist view, the need to complement the Maastricht design with institutional innovations has brought along a very advanced banking union, significant progress on macroprudential policies, sustained efforts to create a Capital Market Union, a tool, the ESM, to deal with idiosyncratic shocks, a sub optimal but still not irrelevant machinery to guide national fiscal policies under the guise of the GSP and related rules, an important progress towards a common fiscal policy, under the guise of the Next Generation EU fund, also advancing towards economic and political union, and a highly performing central bank. Does a renewed estimate that about 2/3 of the institutional innovations that were needed to complement the Maastricht design have been accomplished raise many disagreements in the audience today?

My bottom-line is that, as the economists insisted, the euro area was not a fully-fledged monetary union when the euro was launched in 1999. However, the monetarists were right that launching the single currency would trigger a dynamics that would, over time, complement the incomplete design. To put it dramatically: launching the euro was an imprudent initiative, but the imprudence was, to a large extent, remedied in the following 20 years, albeit at a cost. Without  that imprudent initiative we would not have the euro and, as Fabrizio wrote in our common piece in 1993, “Monetary Union would (have remained) in such a distant future as to become hardly visible, a sort of decoy hare used at dog races to keep the hounds running but not really expected to be eaten by them.” In less canine metaphoric terms, Monnet had made the same point: “Si nous attendons, pour agir, que toutes les questions aient trouvé leur réponse, nous n’agirons jamais, nous n’atteindrons jamais la certitude attendue et nous serons entraînés par les événements que nous aurons renoncé à orienter.” (Speech at the National Press Club in Washington DC: April 30, 1952).

My hunch is that without the euro we would be worse off. But this is the subject for another time.


[1] Kenneth Dyson and Ivo Maes, Architects Of The Euro. Oxford University Press 2016.

[2] The Saccomanni and Papadia contribution in the book edited by Steinherr also clearly belongs to the monetarist tradition.

[3] Tommaso Padoa-Schioppa And Gunther Baer, the Werner Report revisited. In Report on economic and monetary union in the European Community, April 1989

[4] Working Paper Series No. 468 / 2XXX April. Endogeneities Of Optimum Currency Areas. What Brings Countries Sharing A Single Currency Closer Together?  By Paul De Grauwe  And Francesco Paolo Mongelli.


[6] Commission Staff Working Document. Guidance To Member States Recovery And Resilience Plans. September 17th 2020.