Monetary Policy Autonomy in European Non-Euro Countries, 1980–2005
| Author | Vera E. Troeger,Thomas Plümper |
| Published date | 01 June 2006 |
| DOI | 10.1177/1465116506063708 |
| Date | 01 June 2006 |
| Subject Matter | Articles |
Monetary Policy Autonomy in
European Non-Euro
Countries, 1980–2005
Thomas Plümper
University of Essex, UK
Vera E. Troeger
University of Exeter, UK, and Max-Planck-Institute of Economics, Jena
ABSTRACT
We argue that the European currency union (ECU) reduced
the de facto monetary policy autonomy of EU countries
abstaining from introducing the euro. The large share of
imports from euro zone countries renders a close alignment
of monetary policy to the interest rate set by the European
Central Bank (ECB) necessary if the monetary authorities of
countries outside the ECU want to impede the import of
inflation from the euro zone or a declining competitiveness
of the domestic industry. In turn, the increasing role of the
euro as an international reserve medium equal to the US
dollar reduced the monetary policy autonomy of countries
importing more goods and services from the euro zone than
from the dollar zone. An empirical analysis of monetary
policy in the United Kingdom, Denmark and Sweden lends
support to our theoretical argument. Analysing the short-
term adjustments of central bank interest rates in these three
EU countries, which did not introduce the euro, we show
that these countries’ monetary policies more closely follow
the ECB’s policy than they followed the Bundesbank’s policy
before 1994. In addition, we demonstrate the diminishing
influence of the dollar on monetary policy in the UK,
Denmark and Sweden since the countries of the Economic
and Monetary Union harmonized monetary policies.
213
European Union Politics
DOI: 10.1177/1465116506063708
Volume 7 (2): 213–234
Copyright© 2006
SAGE Publications
London, Thousand Oaks CA,
New Delhi
KEY WORDS
currency union
euro
monetary policy
monetary policy
autonomy
optimal currency area
Ironically, the two sides of one debate sometimes refer to identical arguments.
During the negotiations for a common European currency, John Major – then
a rising star within the British Conservative Party and soon to be successor
of Margaret Thatcher – opposed the introduction of the euro, arguing that it
would remove monetary and fiscal policy autonomy from the member
governments, including of course that of the United Kingdom. In a reply to
these reservations, the German Chancellor Helmut Kohl claimed that a stable
euro would ‘Thatcherize’ the continent by imposing needed fiscal and
monetary responsibility on countries such as France and Italy (New York Times,
30 April 1997). Obviously, Major and Kohl had little if any disagreement over
the consequences of a common European currency in respect to monetary
policy autonomy. However, they drew opposing conclusions from the very
same point.
At the end of the day, both politicians got their way. While 12 EU
countries, including Italy and France, introduced the euro, three countries,
namely Denmark, Sweden and the United Kingdom, abstained from aban-
doning their national currencies. In all three defecting countries, the decision
to reject the euro resulted from an inextricable melange of public reservations
against the euro, a general Euroscepticism, national pride and a positive
attitude towards policy autonomy.
Yet, although the desire to maintain political autonomy in monetary
policy provided one of the main reasons not to join the European currency
union (ECU), the introduction of the euro did not leave the monetary policy
of the bystanders unaffected. We argue that the introduction of the euro de
facto reduced monetary policy autonomy for non-euro EU countries – thus
gradually reducing the potential gains from remaining outside the euro area.
Since the maintenance of monetary policy autonomy is a major incentive not
to join a currency union, the decline in de facto monetary policy autonomy
should, ceteris paribus, reduce the disincentives to join the union. Hence, the
politics of ‘splendid isolation’ in monetary affairs did not fully pay off for the
EU countries keeping their own currency. If the defence of political room for
manoeuvre provided a major reason for shying away from the European
currency union, governments proved to be at best partially successful.
Our argument depends on the observation that, when a monetary author-
ity lowers the central bank interest rate or increases money supply, the
domestic currency almost certainly depreciates. In turn, the prices of imported
goods rise, implying a net wage loss for all voters. As a consequence, govern-
ments in democratic countries have strong incentives to avoid real deprecia-
tions of their currency against the currencies in which imported goods are
denominated. The de facto monetary policy autonomy of governments can
be low even if they maintain full legal autonomy.
European Union Politics 7(2)
214
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