In the Absence of Fiscal Union, the Eurozone Needs a More Flexible Monetary Policy

This paper makes three points. The first is that external imbalances between Member States are relevant for the performance of a monetary union when the latter is not backed by a strong political commitment and a solid political framework. Eurozone policymakers have ignored these inter-member imbalances and have instead concentrated on union-wide imbalances, so much so that statistical data on the former phenomenon still remain largely incomplete. There are signs that a correction is in the making, which we hope will lead to a comprehensive quantitative knowledge of intra-EMU imbalances. The second objective of the paper is to design specific policies aimed at reducing inter-member external disequilibria, for example by fixing targets on current-account imbalances symmetrically applied to both deficit and surplus countries. The contrast between the keen attention of the EZ policymakers on national fiscal imbalances and the belated and lukewarm attention given to external imbalances is striking. The third aim of the paper is to propose a more flexible monetary policy aimed at controlling the distribution of liquidity among Member States, resulting from inter-member external imbalances. Our proposal is that National Central Banks should add a risk premium cost to official interest rates on banks that accumulate “excessive” borrowings or deposits to compensate, respectively, for outflows and inflows of the monetary base due to the effect of external imbalances