Podium - The euro will lead to European union

Otmar Issing From the Hayek Lecture delivered at the Institute of Economic Affairs by a member of the European Central Bank board
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AS A young student I read The Road to Serfdom. It was the first book written by Hayek I came across, and it has left a deep influence on me. Only 11 years after the Hitler regime and the war, I suddenly started to understand the interdependence between totali- tarianism and economic policy. Since then I have read most of Hayek's publications.

Hayek held some strong views on Monetary Union in Europe, an idea that was still only in a rather embryonic stage when he commented on it in 1978. His own scheme of competing currencies seemed to him "both preferable and more practicable than the utopian scheme of introducing a new European currency, which would ultimately only have the effect of more deeply entrenching the source and root of all monetary evil, the government monopoly on the issue and control of money".

The proposal put forward by Hayek, that is, full competition between private issuers of currency, is an extremely interesting concept. The basic idea seems to be as follows: creating the possibility of banks issuing currency would open the way to competition. The currencies of different banks would trade at variable exchange rates. Competition and profit maximisation would lead to an equilibrium in which only banks paying a competitive return on liabilities could survive.

Only currencies guaranteeing a stable purchasing power would exist. Banks that failed to build up such a reputation for their currency would lose customers and be driven out of business.

How would Hayek, if he were alive today, see EMU and the ECB? Let me hazard what is probably a somewhat biased and speculative answer. The route to monetary union taken by member governments and central banks was almost diametrically opposed to that espoused by him in his later writings. But should he not welcome what we have achieved?

I am convinced that he would welcome the fact that the ECB has not joined the new, fashionable wave arguing that money does not matter. It is very easy to slip into the trap of thinking that money is unimportant when inflation is low, and to ignore the overwhelming evidence that all past episodes of persistent inflation have been preceded, or been accompanied, by rapid money growth.

Since inflation is ultimately a monetary phenomenon, money constitutes a natural, firm and reliable "nominal anchor" for a monetary policy aimed at price stability. This accounts for why money is given a prominent role in the ECB's monetary policy strategy.

Therefore, although the path taken to achieve denationalisation of money has been very different from that advocated by Hayek, the ultimate objectives being sought by Hayek, ie monetary independence from political interference and price stability, have, to all intents and purposes, already been achieved.

Of course, I should add as an essential precautionary note, that price stability is never fully achieved in the sense that it is a forward-looking concept and the ECB must be eternally vigilant, and act in a pre-emptive way, so as to ensure that inflationary pressures are not given an opportunity to translate into actual inflation. Having said this, however, I am afraid Hayek might not be in favour of a new centralised authority with monopoly powers over base money. The Treaty of Maastricht is virtually the very opposite of what Hayek proposed, because, among other things, the new monetary order in the EU11 has been created not in an evolutionary process but in a "constructivist" way by statute. In the sequencing of events on the road to the political integration of Europe, I once had a distinct preference for political union preceding monetary union. I have argued elsewhere, historical experience shows that national territories and monetary territories normally coincide. Now, of course, the reality is that, if political union is ever to occur, monetary union will have preceded it.

However, with the establishment of the ECB and the introduction of the single currency, a process towards further political integration has been triggered. What is essential for a successful monetary union is a sufficient degree of political commitment by all participating countries, the leading economic actors, and the wider public to accept fundamentally and genuinely the political and economic constraints that a single and stable currency represents.

Some degree of political unity (not necessarily union), would appear to be important for the long-run health of EMU. However, it is not a substitute for the right economic conditions for lasting success.