The founders of the euro had little doubt about the common currency’s role as a foundation for European peace and prosperity. Yet, they were not Pollyannas. For years before the start of monetary union in 1999, economists had warned that the member states of the European Union do not constitute an “optimum currency area” (see, for example, Milton Friedman). This means that a single policy interest rate might exacerbate, rather than mitigate, economic differences, creating severe strains among euro area countries.

Since the euro’s beginning, European leaders hoped and expected that as tensions arose, member states would come closer together—integrating their economies and financial systems, sharing burdens and risks. To a considerable extent, experience has borne out these hopes. Despite enormous challenges, no country has abandoned the euro and reintroduced a national currency. Today, an entire generation of people has come of age knowing only the euro. Moreover, as of November 2019, popular support for the single currency among euro area residents was at a record 76%, with sizable majorities in each member state (see Eurobarometer 92, pages 32-33).

And yet, over the past two decades, there has been only grudging progress toward a truly resilient monetary union. Politically and financially, the euro area remains divided. The COVID-19 crisis brings renewed tensions. With it comes a harsh reminder that standing still is simply not an option.

In this post, we review the progress toward completion of the European monetary union, and note key gaps that remain….

Italeave: Mother of all financial crises

After years of calm, fears of a currency redenomination—prompted by the attitudes toward monetary union of Italy’s now-governing parties and the potential for another round of early elections—revived turbulence in Italian markets last week. We have warned in the past that an Italian exit from the euro would be disastrous not only for Italy, but for many others as well (see our earlier post).

And, given Italy’s high public debt, a significant easing of its fiscal stance within monetary union could revive financial instability, rather than boost economic growth. Depositors fearing the introduction of a parallel currency (to finance the fiscal stimulus) would have incentive to shift out of Italian banks into “safer” jurisdictions. Argentina’s experience in 2001, when the introduction of quasi-moneys by the fiscal authorities undermined monetary control, is instructive….

The Fed's Price Stability Achievement

Over the past decade, critics of all stripes have assailed Federal Reserve monetary policy. At one end of the spectrum, some argued that the Fed’s expansionary balance sheet policy risked currency debasement and high inflation. While some of these critics sought merely to influence ongoing policy, others called for replacing the Fed altogether, and restoring the Gold Standard. And then there were those promoting oversight over monetary policy operations that would significantly curtail central bank independence.

At the other end, a different set of critics worried about outright deflation: according to monthly averages from Google Trends, since 2004, U.S. searches for deflation were twice as frequent as those for hyperinflation. Some economists called for a higher inflation target. Squarely in the second camp, officials inside the Federal Reserve System developed deflation probability trackers like this one (here is another from the Federal Reserve Bank of Atlanta).

These diverse perspectives form the backdrop to this year's report for the U.S Monetary Policy Forum (USMPF) that we co-authored with Michael Feroli, Peter Hooper and Anil Kashyap. In that paper, we document that the trend in U.S. inflation has been remarkably low and stable since the early 1990s....

The Map is the Message: Regional Feds versus Euro-area NCBs

Some time ago, we wrote about how the Fed and the ECB’s governance and communication were converging. Our focus was on the policy, governance and communications framework, including the 2% inflation objective, the voting rotation, post-meeting press conference, prompt publication of meeting minutes, and the like.

But important differences are built into the legal design of these two systems. Perhaps the most important one is the contrasting roles of the regional Federal Reserve Banks and that of the National Central Banks (NCBs)...

A Swiss Lesson in Time (Consistency)

You can set your watch by the Swiss trains. They are the envy of the world in many ways. Everyone believes that the trains will run on time because they do.

Credibility is at the core of central banking as well. When a credible central banker speaks, households, businesses, and governments listen. And, because they expect the banker to do what she says, their response – measured in terms of how much they work, save, and invest – will reinforce the outcome policymakers seek.

But credibility is tough to earn and – as the Swiss National Bank (SNB) recently learned when it ended a three-year commitment to prevent a rise in the franc versus the euro – easy to lose....

The Importance of Being Europe

If Oscar Wilde were still around, he could write a wonderful comedy about European Economic and Monetary Union (EMU). Like the life of his protagonist, Ernest John, the evolution of EMU is rarely pure and never simple. But it would take a Wilde imagination to see exactly how EMU gets to a happy ending.

Despite its name, EMU was not and is not primarily an economic endeavor...

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