GREATER E S E E M U - Cato Institute.pdfVIP

DOES A LESS ACTIVE CENTRAL BANK LEAD TO GREATER ECONOMIC STABILITY? EVIDENCE FROM THE EUROPEAN MONETARY UNION Elham Mafi-Kreft and Russell S. Sobel On January 1, 1999, 11 European countries gave up the indepen- dence of their monetary policy by joining the European Monetary Union (EMU). Since that time, these countries have shared a com- mon currency, the euro, and, more important, are all now under the direction of a common European Central Bank (ECB) that controls monetary policy for the entire euro area. In accordance with Article 105(1) of the Maastricht Treaty, the primary objective of the ECB is to maintain price stability. The institutional designs of the ECB as well as their stated primary objective lead most economists to believe that the new ECB is a relatively inactive central bank in the pursuit of short-run macroeconomic stabilization. Thus most, if not all, of the countries in the EMU are now under a central bank that is much less active than was their previous national central bank. In this article, we examine whether this shift in the activism of the monetary regime has resulted in more or less macroeconomic stability for these countries. Even before the official starting date for the EMU, a substantial academic literature speculated on how the move toward a common central bank would affect the macroeconomic stability of these coun- tries. This literature has generally concluded that the movement to- ward a common central bank would make these economies more unstable because of the inability of a common central bank to tailor monetary policy to the needs of each country. As each country expe- riences country-specific shocks, the ECB will not be able to counter Cato Journal, Vol. 26, No. 1 (Winter 2006). Copyright © Cato Institute. All rights reserved. Elham Mafi-Kref