Reforming the European Monetary Union

V. V. Chari, Consultant

Alessandro Dovis

Patrick J. Kehoe, Consultant

May 2017 | Federal Reserve Bank of Minneapolis Economic Policy Paper 17-3

We offer a theoretically based narrative that attempts to account both for the formation of the European Monetary Union (EMU) and for the challenges it has faced. Lack of commitment to policy plays a central role in this narrative and leads to four policy implications for EMU redesign.

  1. Should the union be dissolved?
    No, the union was formed for good reasons, and dissolving it might lead to high and variable inflation.
  2. Should the union have a bailout fund, and, if so, how large should it be?
    Yes, but making this fund large runs the risk of increasing the likelihood of crises in which countries need bailouts.
  3. Should bank regulations be centralized?
    Yes.
  4. What constraints on fiscal policy are desirable?
    Constraints on the maturity structure of debt are desirable and perhaps enforceable, while constraints on the total amount of debt are clearly not.