The Formation of the EMU and Financial Stability Policies: Fragmented Policy-Making Processes and Current Agendas

Abstract

The paper analyzes the limitation of the Economic and Monetary Union (EMU) to pursue financial stability policies by pointing out the problems of fragmentation in the policy-making processes. Fragmentation was due to delegating monetary policies to the European level under the authority of the European Central Bank (ECB) while essentially confining fiscal policies and financial supervisory policies to national boundaries (at least until the Banking Union is implemented in 2014). The paper first reviews various lines of argument to explain the process of reaching agreement on the EMU and finds that one of the major factors in support of the EMU was its complementarity with German business interests.
Moreover, the paper discusses the policy implications of the EMU by examining the role of the ECB. It focuses on the institutional characteristics of the ECB―such as institutional independence and priority given to price stability―as well as the policy environment impacting its actual functions. New institutionalism implies that institutions could produce unanticipated results due to the complexity of contexts where they function (Pierson 2004, Mahoney and Thelen 2010). Despite the fact that the ECB’s characteristics originated from the German Bundesbank, these central banks’ policies could lead to different outcomes. For example, as Hall and Franzese (1998) and Garrett (1999) discuss, trade-off issues between unemployment and price stability could be more serious in the Eurozone due to its lack of coordinated wage-setting process. In a similar vein, in a field of financial stability policies, investors can rely less on the ECB’s commitment to ensuring financial stability (than as is the case in Germany), thus escalating their fears over financial markets. This problem can be attributed to: ⑴ uncertainty involving the ECB’s role as lender of last resort, ⑵ a lack of investor of last resort in the European level, and ⑶ disjuncture between financial supervisors, fiscal authorities, and the monetary authority.
In addition, the paper examines current agendas associated with the 2008-10 financial crises. The ECB expanded its role in financial crisis management through handling these crises. Furthermore, according to recent agreements on the Banking Union, it was decided that the ECB would gain financial supervisory powers in the Eurozone. The paper discusses what kinds of problems remain after such institutional change and points out the ECB’s accountability problems in the context of its enhanced role in financial stability policies.