United in diversity – Challenges for monetary policy in a currency union

Isabel Schnabel of the ECB in this speech discusses the major challenge for monetary policy in a monetary union is to remain united in diversity:

One illustrative symbol of this unity in diversity are our euro coins, with the map of Europe on one side and a country-specific symbol on the other. The euro unites us.

Yet, diversity also brings about challenges – and that is what I will talk about today.

The euro area consists of 19 – soon 20 – different countries, each with its own economic structure, societal governance and fiscal policy. The natural consequence is that shocks that hit the euro area, be it a financial crisis, a pandemic or a war, affect each euro area country differently.

Today’s inflation is a case in point. Harmonised consumer price inflation in the euro area as a whole is at a record high, reaching 8.1% in May according to the most recent flash estimate. But there are large and unprecedented differences across countries (Slide 2). In Estonia, for example, inflation stood at 20% in May, while it was less than 6% in Malta and France.

How countries produce and use energy accounts for a large part of these differences. But energy is only part of the story. The war, like the pandemic, has had differential effects on consumption, investment and fiscal policy, and hence on underlying price pressures.

The pandemic was a stark reminder that such differences can seriously impede the conduct of monetary policy. In the spring of 2020, concerns about some countries’ perceived lack of fiscal space to deal with the pandemic led to a sharp divergence of financing conditions across euro area economies, thereby severely disrupting the transmission of monetary policy.

I will argue that the vulnerability to such fragmentation risks will only disappear with fundamental changes to the euro area’s institutional architecture. Therefore, monetary policy needs, at times, to respond to market developments that undermine the smooth transmission of monetary policy.

That said, the progress we have made over the past years in strengthening the resilience of the currency union, on both the fiscal and the monetary side, has helped to reduce the likelihood that disruptive and self-fulfilling price spirals in government bond markets threaten the cohesion of the single currency.



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