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The Sustainability of Monetary Stability

 

JEL-Keywords: Inflation, International Monetary Arrangements and Institutions, Central Banks and their Behaviour.
JEL-Classification: E31, E58, F33.

Policy preferences have changed over the last 20 years. Price stability is today an objective of common concern. The countries have learned to live in an environment of low inflation. How does Monetary Union sustain such a behaviour?

The European Central Bank - Guarantor for price stability

  • The Treaty on European Union clearly establishes a preference for price stability over other objectives.
  • The Maastricht Treaty provides institutional backing together with constraints on budget policies.
  • The European Central Bank (ECB) is the institution charged to pursue price stability and it has one of the highest degrees of political independence in the world in order to do so.
  • Over the past 20 years there has been an emerging consensus among central bankers. Throughout the world, central bankers agree today on price stability as the primary goal of monetary policy. This will also be the case for the ECB. In Europe this commitment is expressed by the significant convergence in price stability, and the simultaneous reduction in nominal interest rates since the 1980s is a manifestation of this consensus.

Wage development to support price stability and rise employment

  • Price stability can only be guaranteed if all economic agents behave in line with the central bank’s stability commitment. This applies in particular to wage bargainers.
  • Excessive wage growth raises domestic production costs and translates into general price inflation. When the central bank refuses to accommodate inflation, the fixed amount of nominal money balances will restrict real economic growth and cause unemployment.
  • To keep inflation low and prevent unemployment from rising, unit labour costs, i.e. money wages adjusted for differences in productivity levels, must not rise.

In conclusion, the report reveals that, despite famous structural rigidities, the development of labour costs in countries eligible for EMU membership does not pose an obvious danger for the new currency’s sustainability.

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