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The ECB has been arguing in the past that since there is no trade-off between price stability and financial stability, the pursuit of price stability is the best a central bank can do to also maintain financial stability. We argue that there is a potential trade-off between price stability and financial stability. In order to make this trade-off less constraining we propose that the two-pillar strategy of the ECB should be reformed. In this new two-pillar strategy, the ECB should pursue two objectives, i.e. price stability and financial stability. In this new strategy the interest rate should be used to achieve the inflation objective, while other instruments (minimum reserve requirements and macro prudential control) should be used to achieve financial stability.

SummaryThis paper explores the conflict of real and monetary convergence during the EMU run‐up of the Central and Eastern European member states. Using a Balassa‐Samuelson model of productivity driven inflation, we find a high probability of higher inflation in the new member states. We compare the policy options which make the compliance possible, i.e. fiscal tightening and nominal appreciation within the ERM2 band. Nominal appreciation within ERM2 seems the better option to achieve the compliance with the Maastricht criteria, as no discretionary government intervention is necessary, and losses in terms of real growth are smaller. Having once opted for nominal appreciation by fixing the ERM2 entry rate as the central rate (Irish model), a high degree of flexibility is provided in coping with erratic short‐term capital inflows. The strategy of setting the ERM2 entry rate above the central rate (Greek model) implies a clear exchange rate path within ERM2 and thereby less exchange rate volatility. Despite the merits of nominal appreciation, countries committed to hard euro pegs, or with high budget deficits, may choose fiscal contraction as a solution.

Abstract.  We provide evidence indicating that countries with well developed social security systems do not necessarily face a trade‐off between social spending and competitiveness. On average, countries that spend a lot on social needs score well in the competitiveness league. We investigate the importance of a reverse causality from competitiveness to social spending, and find that this is weak. We also present some possible explanations for our empirical finding. Finally, we interpret our findings in the framework of a theoretical model in which risk affects the size of the social sector and social spending affects the production function of the private sector.

The financial crises of the 1990s have created the perception that one of the fundamental reasons for the occurrence of such crises is to be found in the fact that exchange rates were pegged for too long. These pegged exchange rates inevitably invited speculative attacks in the foreign exchange markets that quite often spilled over to the banking sector, and led to banking crises. Recently, the analysis of the financial crises has led to a new consensus among policy makers, i.e., the bipolar view (see Fischer, 2001). According to this view, countries should allow for either flexible or irrevocably fixed exchange rates in order to avoid future crises while the intermediate solutions, such as pegged exchange rate regimes, should be avoided. The advantages of such intermediate exchange rate regimes have been offset by the disadvantages in terms of uncertainty in the financial markets. In this paper we analyse this link between the exchange rate regime and the probability of financial crises. We first analyse in the next section the relation between the exchange rate regime and the occurrence of foreign exchange crises, while Section 3 briefly reviews the associated empirical evidence. We then study the relation between the exchange rate regime and the occurrence of banking crises (Section 4). This analysis will also allow us to connect crises in the foreign exchange markets and banking crises. Section 5 concludes.

Paul de Grauwe s'insurge dans cet article contre le risque d'une interprétation trop rigoriste, voire fétichiste, des critères de Maastricht. Le critère de convergence inflationniste est déjà suffisamment respecté ; celui de convergence des taux d'intérêt est dangereux car il met en jeu une dynamique autoréalisatrice vulnérable aux comportements spéculatifs et privant les politiques de la responsabilité du choix. Quant aux critères budgétaires, leur raison d'être et leur relation au problème de l'union monétaire ne reposent que sur des arguments bien ténus. Il est donc temps de proclamer la « victoire de la convergence » et de décider que l'Union monétaire se fera dans les délais, avec tous les pays qui le souhaitent (à l'exception possible de la Grèce).