Putting EMU to work

With EMU, price stability has gained in importance over other policy goals such as growth and employment. The leading idea has become to fight and to control inflation in the hope that growth and investment will automatically follow. The first part of the paper discusses the potential benefits but also the costs of taking low inflation and price stability as an overriding policy objective. It argues that the benefits of reaching very low inflation are overrated, while the costs are underestimated. A second part of the paper turns to the current situation and policy discussion. EMU and the European Central Bank become operational in an environment of extremely low inflation, while at the same time external conditions (the global financial turmoil) are triggering a slowdown in economic growth. In this context, monetary policy has a heavy responsibility in ‘stabilising’ the business cycle and maintaining satisfactory investment rates. We argue that central banks in Europe in the past did not take up this responsibility, not even in the context of low inflation and tight fiscal policies. The essential question therefore is whether EMU represents a structural change in policy regime. A final section formulates a number of practical proposals that can increase the probability of such a shift in the policy regime of EMU so that EMU is effectively rebuilt as an instrument for price stability and employment.