Money, prices and the transition to EMU

The third stage of the Economic and Monetary Union will start on January 1st, 1999, at which point the currencies of the participating countries will be irrevocably fixed as the prelude to the introduction of the euro by 2002. Although the European System of Central Banks’ objective is clearly defined in its statute as achieving and maintaining price stability, the strategic and tactical question of how to formulate and execute the future common monetary policy is left open. This work contributes to the current discussions on this topic by investigating whether monetary aggregates can play a useful role in the monetary policy decision process in the second or third stage of the EMU. To do this the authors employ an extended open-economy version of the standard P*-model developed by Hallman, Porter and Small (1989 and 1991) to examine to what extent inflation behaviour in five founding members of the ERM can be ascribed to either domestic or European monetary conditions from 1973 to 1994.