KATHLEEN R. MCNAMARA

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Journal of Common Market Studies

September 1999

Blackwell Publishers Ltd 1999, 108 Cowley Road, Oxford OX4 1JF, UK and 350 Main Street, Malden, MA 02148, USA

Consensus and Constraint: Ideas and Capital

Mobility in European Monetary Integration*

Vol. 37, No. 3

pp. 45576

KATHLEEN R. MCNAMARA

Princeton University

Abstract

The critical foundation for European monetary integration is the neoliberal

economic policy convergence that occurred across the majority of the Europe-

an governments beginning in the mid-1970s and solidifying in the 1980s.

While capital mobility determines the conditions under which international

monetary agreements can be sustained, political leaders policy ideas or shared

normative and causal beliefs about monetary policy are necessary to explain

whether states choose to meet those conditions. These ideational factors are

critical in part because of the high degree of uncertainty over the distributional

effects of exchange rate and monetary co-operation, ambiguity which mutes

both mass political debate and sectoral interest-group activity. A template ofideational change is thus proposed to explain the path of European monetary

integration.

* Earlier versions of this paper were presented at the Annual Meeting of the American Political ScienceAssociation, Washington, D.C., 2831 August 1997 and the Biannual Meeting of the European CommunityStudies Association, 29 May 291 June 1997. It draws on material elaborated in McNamara (1998). I am

grateful to the Woodrow Wilson School at Princeton University and the German Marshall Fund for financialsupport; and to Sheri Berman, David Cameron, two anonymous reviewers and the editors for their comments.


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Blackwell Publishers Ltd 1999

KATHLEEN R. McNAMARA

I. Introduction

Long before the birth of the euro in 1999, monetary co-operation was a keyconcern of European political leaders. A series of fixed exchange rate agree-

ments had been pursued by policy-makers in the post-war era as a way toencourage trade and investment by stabilizing currency fluctuations among thehighly open economies of the common European market. Monetary co-opera-tion has also had a purpose beyond the economic realm, acting as a central anchor

for debates about political unification in the European Union (EU). Since itsinitial proposal in the Werner Report of 1970, Economic and Monetary Union(EMU) has been promoted by European leaders as a way to ensure a peaceful,stable future for a continent with a history of violent conflict among its states. Thecreation and maintenance of a multilateral fixed exchange rate regime has been

viewed as an important precursor to this end.Despite this desire for monetary stability, EU governments have had an

uneven record of success with monetary co-operation in the decades prior toEMU. Although European exchange rates were stabilized in the first decades ofthe post-war era within the Bretton Woods international monetary system, theEuropean-only currency Snake effectively collapsed after a few years of oper-ation in the early 1970s. Yet the next European regime, the European Monetary

System (EMS) begun in 1979, proved surprisingly durable through the 1980sand 1990s. Indeed, the success of the EMS was a major impetus for the singlecurrency ambitions of the Maastricht Treaty. This mixed record constitutes anempirical puzzle for those studying the progress of European integration: itsresolution may shed light on the future path of EMU, as well as helping explainmore generally why international monetary regimes succeed or fail.

In this article, I argue that the critical foundation for progress in European

monetary integration is the economic policy convergence that occurred acrossthe majority of the European governments beginning in the mid-1970s andsolidifying in the 1980s. A neoliberal policy consensus that elevated the pursuit

of low inflation over growth or employment replaced the Keynesian beliefs ofpolitical elites, ultimately contributing to a downward convergence in inflationrates across Europe. This monetary policy consensus redefined state interests inco-operation, underpinned stability in the EMS, and induced political leaders toaccept the domestic policy adjustments needed to stay within the system. Thoughthis monetarist-influenced consensus was by no means unwavering or monolith-ic and is showing signs of wear, it represented a clear break with the divergenteconomic policy paths and diverse priorities of Keynesianism as practised by theEuropean states during the Bretton Woods era. For students of politics, this

European reorientation is particularly notable because it occurred across most ofthe EU states, regardless of political party or domestic institutional structure.


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457IDEAS AND CAPITAL MOBILITY IN EUROPEAN MONETARY INTEGRATION


Policy consensus has been noted by others as key to the progress of Europeanintegration (Sandholtz and Zysman, 1989; Pauly, 199192; Moravcsik, 1991;Sandholtz, 1993).1Yet a series of important questions raised by this contentionremain unanswered, particularly in the monetary realm. Why was the neoliberal

policy consensus crucial to the success of the EMS? Where did it come from, andwhat were its political foundations? What might cause cracks in these founda-tions? And if this neoliberal policy consensus is so important, how were theEuropean states able to stabilize their currencies within the earlier BrettonWoods system before such a consensus developed in the 1970s?

To answer these questions, I explore the interaction between a changinginternational economy, one in which capital flows have increased exponentially,

and the domestic policy-making process, particularly political leaders beliefsabout macroeconomic strategy. I argue that capital mobility plays a critical role

in determining the conditions under which international monetary agreementscan be sustained (Cohen, 1993; Andrews, 1994; Webb, 1995; Pauly, 1997). Suchstructural features do not dictate policy choice, however. Political leaders ideas,defined here as shared normative and causal beliefs, are crucial to explainingwhether states choose to take the steps necessary to meet those conditions (Hall,1992, 1993; Sikkink, 1991; Goldstein, 1993). Political actors use these ideas toevaluate the costs and benefits of monetary co-operation and chart a policycourse. Policy-makers draw on these ideas to formulate answers to questions of

values and strategies: what should the goals of monetary policy be, and whatinstruments can be used in pursuit of those goals? The answers will varysignificantly over time and place, as human agency, in the form of interpretation,

interacts with the structural features of capital mobility to define nationalinterests in international monetary co-operation.

Ideas, as Thomas Risse-Kappen has stated, do not float freely however;they arise from actors experiences with their environment and interactions withother actors, and they survive implementation into policy only if they arepolitically salient (Risse-Kappen, 1994). Thus, to explain why neoliberal eco-

nomic policy ideas triumphed within the political arena, making Europeanmonetary co-operation more likely, I develop a template for understanding whycertain ideas become dominant at a given historical point, while others are putaside. A process of perceived policy failure, policy paradigm innovation, andpolicy emulation unfolded among the states of the EU, replacing Keynesianismwith a new, neoliberal view of monetary policy, in the years between the creation

of the Snake and the EMS. Other paths were possible, as demonstrated by themany states in the defunct Bretton Woods system, such as those of the UnitedStates and Japan, which moved to floating exchange rates and less stringent

1In particular, Sandholtz (1993) is notable for pointing out the nature and importance of the monetary policyconsensus for the development of EMU.


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monetary policies. Indeed, this template of ideational change indicates not theinevitability of convergence, but instead its contingency. The elite nature of thisprocess also reveals the weakness of the political basis for EMU, which hascontributed to exchange rate crises in the past and may undermine the ultimate

durability of EMU as it is presently constituted.The rest of this article proceeds as follows. I first present a simple, well-

accepted macroeconomic model for understanding the implications of capitalmobility for monetary co-operation and then apply it to the historical experienceof post-war Europe with fixed exchange rate regimes. Second, the role of ideasin monetary policy-making is analysed and their impact on European monetaryintegration is described. Placing my arguments within a larger theoretical and

historical perspective, the final section considers the future of European mone-tary union.

II. Capital Constraints: Mundells Holy Trinity

Changes in the world economy have reconfigured the set of options governmentsface when pursuing monetary co-operation. A variant of the Mundell-Flemingmodel, a central framework in modern macroeconomic theory which has becomewell accepted among policy-makers today, is a useful way to describe why this

was so. This theoretical proposition was formally known as Mundells assign-ment problem, but is often referred to as the Holy or Unholy Trinity(Mundell, 1960; Cohen, 1977; Rose, 1994). It sketches out the interactionbetween domestic policy choices and multilateral exchange rate co-operation ascapital markets become increasingly integrated and the volume of capital flowsrises. According to this proposition, policy-makers can choose only two of the

three following policy options at any one time: free capital flows; a fixedexchange rate; and monetary policy autonomy. Thus, if a government wishes tokeep its exchange rate fixed in the context of international capital mobility,national monetary policy must be used to maintain the exchange rate parity and

cannot be directed towards other internal goals.2

Mundells framework does not dictate which two of the three policy optionsstates will choose at any point in time. However, it merely outlines the logicalincompatibility of having all three simultaneously. It also provides a usefulframework for interpreting the broader history of international monetary re-gimes, as shown in Table 1.

2In contrast, fiscal policy under the broader Mundell-Fleming model is predicted to be more effective withcapital mobility and a fixed exchange rate than if rates were flexible or capital constrained. Indeed, the

European states did largely follow domestic imperatives over much of this time period in managing theirfiscal policies (Garrett, 1998) as is discussed at the end of this essay (see also Roubini and Sachs, 1989; Grilli

et al.,1991; De Haan and Sturm, 1994; Clark and Hallerberg, 1998).


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Table 1: Capital Mobility and International Monetary Systems: The Holy Trinity in

Historical Perspective3

Monetary Regime Economic Policy Options

Autonomous Fixed

Capital Monetary Exchange Mobility Policy Rates/Co-operation

Bretton Woods No Yes Yes

(194571) (Low levels)

European Currency Yes Yes No

Snake (197278) (Rising) (attempted, but failed)

European Monetary System Yes No Yes

(1979present) (High)

Note: Only two of the three policy options can be met at any one time.

To understand how European governments have gone about choosing policies

given the trade-offs Mundells framework outlines, it is helpful to start with theBretton Woods international monetary regime as a baseline. The Bretton Woodssystem, which included, among others, all the states of what is today the EU, wascreated in 1945 and lasted until 1971.4 Responding to domestic political neces-

sities and supported by American hegemony, Bretton Woods was set up byBritish and American policy-makers so as to allow policy autonomy to coexistwith fixed exchange rates in what John Ruggie has called the compromise ofembedded liberalism (Ruggie, 1982). Embedded liberalism refers to the ideathat Bretton Woods was liberal in the sense of encouraging internationaleconomic transactions, but its liberalism was tempered by, or embeddedwithin, a larger social context of goals beyond economic efficiency, in contrastto the laissez-faireapproach of the nineteenth century (Polanyi, 1944). But theonly way to ensure that this intention could be realized was to limit capital

movements within the system; indeed capital controls were a major preoccupa-tion of John Maynard Keynes when designing Bretton Woods (Ikenberry, 1993).Thus, autonomous monetary policy, fixed rates and low levels of capital mobilitymarked the Bretton Woods years (Cohen, 1977; Solomon, 1982; McKinnon,1993).

3 Detailed empirical support for this classification can be found in Chs 46 of McNamara (1998).Measurement problems make econometric evaluation challenging, although Rose (1994) undertakes such a

study which finds support, albeit statistically weak, for Mundells proposition.4Bordo and Eichengreen (1993) provide an excellent overview of the creation, operation and collapse of theBretton Woods system.


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The resurgence in international capital mobility in the late 1960s and early1970s, aided and abetted in part by government action or inaction (Helleiner,1994) therefore had serious consequences for the European governments effortsto sustain a fixed exchange rate regime. After the Snake was created in 1972 in

the wake of Bretton Woods, oil shocks, and stagflation, the rising level andmobility of capital flows were beginning to make the pursuit of fixed exchangerates conditional upon the surrender of monetary policy autonomy. In otherwords, the domestically-driven compromise of embedded liberalism, whichallowed states to expand and contract the national money supply in the quest forfull employment and economic growth, could no longer form a basis formultilateral monetary co-operation within a fixed exchange rate regime. As per

Mundells axiom, capital flows were simply becoming too high to continue tocoexist with fixed rates and policy autonomy.

As will be discussed further below, many of the European governments didcontinue to use autonomous, Keynesian macroeconomic policies oriented to theparticular needs of their domestic polities throughout the Snake period, makingthe maintenance of fixed exchange rates extremely difficult. By the time of thecreation of the EMS in 1979, however, key European governments, mostimportantly France, had begun to eschew domestic policy autonomy, and thisdomestic political shift, while not complete, formed the basis for the achieve-ment of relatively fixed exchange rates in the EMS.5

Mundells framework helps make sense of how capital mobility interactswith national monetary policy-making and monetary co-operation. Yet it onlysets the structural conditions under which governments decide on policy (An-

drews, 1994). It does not tell us what choice governments will make when facedwith these three incompatible policy goals. Although costly, governments canchoose to limit capital mobility in order to regain some policy autonomy andstable exchange rates. Governments also can choose to float their rates ratherthan keeping them fixed, as in the case of those governments that left the Snake.Indeed, many of Bretton Woods former members moved to floating exchange

rates after that systems collapse and have never gone back, and the absence ofan international fixed exchange rate regime has not proved incompatible withrapidly increasing global trade and investment. Left unexplained in this structur-al approach, therefore, is how governments calculate the trade-offs inherent ineconomic policy-making and, in the European case, why governments wereprepared to abandon embedded liberalism in the area of monetary policy.

5For data in support of the increasing degree of nominal exchange rate stability over this period, seeMcNamara (1998) Tables 1 and 2. Of course there have been episodes of currency crises as well, precipitatedboth by political uncertainties and the imperfect convergence in the economies of the EU under conditionsof mobile capital (Walters, 1990).


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III. Ideas and Policy Consensus in Monetary Co-operation

Why were the European states willing to subordinate their national autonomy toexchange rate stability in the case of the EMS but not the Snake? To answer this

question, we must complement the analysis of international capital mobility andthe trade-offs it presents with an understanding of how states interests inmonetary co-operation have been constructed and transformed over the post-warperiod. This focus on interest definition is critically important, for it was the new

convergence in interests that brought about co-operation in the EMS, in contrastto the Snake. National elites ideas about the nature of the domestic economy andthe goals and instruments of monetary policy directly informed their positionson European monetary integration. While the international economic environ-ment is important, as Emanuel Adler has pointed out, the environment does not

instruct policy-makers, it challenges them (Adler, 1991). In the macroeco-nomic realm, policy-makers responses to those challenges cannot be under-stood without attention to ideational factors, in particular, the policy-makersshared normative and causal beliefs about the nature of monetary policy.

Much of the political science literature tends to assume that interests can bedetermined from an actors position in the economy or within the prevailingpolitical order. Actors simply know what is in their interests and act on that

knowledge; interests are given or exogenous in many accounts. But othertheorists have argued that interpretations of the external world, be it marketstructures or power politics, are not unproblematic. Actors must rely on concep-tual frameworks to make sense of the world around them, and their place withinit. The most fundamental critique of the rationalist approach is from the socialconstructivist school (Wendt, 1992; Laffey and Weldes, 1997). However, othershave elected to critique the rationalist approach from within, by using positivist

methods to study the role of ideas (Sikkink, 1991; Goldstein, 1993). That is theapproach taken here.

Ideas are critical in the monetary realm because of continuing uncertainty

over the fundamental workings of the economy, the difficulties of collecting andinterpreting signals from macroeconomic data about the effects of policy, and thelack of agreement over what constitutes correct macroeconomic policy.Conceptual uncertainty about cause and effect relationships in the economyincludes ambiguity over the micro-level distributional effects of exchange rateand monetary co-operation. As Alberto Giovannini has argued, there is littleagreement within the economics profession on a benchmark model for analys-ing the distributional effects of alternative monetary regimes. His analysis ofthree existing models leads him to conclude that economic interests in favor of

a fixed currency versus flexible exchange rates are not easily identifiable andthat the economic effects of a monetary regime are highly contextual that is,


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they change depending on the specific institutional setting and economicconditions at a particular point in time (Giovannini, 1995, p. 312). In a morecomprehensive critique of the limitations of the field, Paul Krugman points outthat the microeconomic foundations of international monetary affairs comprise

one of the weakest areas in the discipline of economics. Krugman writes thatwhile we have some suggestive notions, what we do not have, however, isanything we can properly call a model of the benefits of fixed rates and commoncurrencies (Krugman, 1993, p. 22).

This uncertainty translates into inaction on the part of domestic interestgroups, in contrast to other areas of sectoral and firm activity such as trade policy,and lends more space to the role of interpretation by elite policy-makers.

Industrial interests in the majority of the European Community states haveexpressed a fairly constant preference over the post-war years for exchange rate

stability because of the high level of openness of the EU economies and theirsignificant trade integration. Yet beyond this general policy preference, nationalpolicy-makers are not subject to significant lobbying on exchange rate ormonetary issues. Uncertainty, and the dilemmas of collective action it produces,tend to keep interest group activity to a minimum on monetary issues, as does therelative institutional insulation of the national treasury and central bank officialsfrom direct societal pressures.6In sum, economic structure alone is indetermi-nate in its effects and meaning for policy-making, and uncertainty mutes mass

political debate over monetary integration.Shared normative and causal beliefs, reinforced and institutionalized throughsocial interaction, are thus fundamental to monetary politics (Odell, 1982; Oye,

1986; Hall, 1992, 1993). These beliefs serve as a crucial guide for governmentofficials attempting to analyse the complex technical relationships that make upthe economy, providing them with a meansend knowledge that allows for thedevelopment of economic policies and a lens with which to judge their relativemerits. In other words, these policy ideas can function like flashlights, guidingpolicy-makers by illuminating a specific path through the darkness of crisis and

confusion, and providing them with strategies for achieving their broad interests.The choice of path, or strategy, is not politically neutral, however, but involvesnormative contests in the case of monetary integration, over the balancebetween the state and the market. Neither does the change in ideas occur inisolation, but is the product of interactions within formal and informal multilat-eral institutions (Krasner, 1983; Haas, 1989, 1992; Hall, 1989; Pierson, 1996b).

6For empirical support of this contention, see McNamara (1998), Ch. 2 (see also Gowa, 1988).


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IV. The Creation of A Neoliberal Consensus

The broad outlines of the evolution of policy consensus that produced co-operation in the EMS, despite the challenge of rising capital mobility, are the

following. In the years between the birth of the Snake in 1972 and the creationof the EMS in 1979, the majority of EC states ceased following domestically-oriented, activist monetary policies. The neoliberal policy consensus at the coreof this shift was critically important to the maintenance of the EMS given the

increasingly high level of capital mobility, and formed an important basis for thesubsequent revival of the EMU project.

These neoliberal beliefs, held by key political leaders as described in moredetail below, centred on the need to prioritize price stability above all other goals.The specific contentions can be characterized as follows: first, expansionary

monetary policies used in the hope of stimulating demand and employment willinstead produce inflation and inflationary expectations and are thus counterpro-ductive. Such policies will also prompt financial markets to drive down theexchange rate, further worsening inflation and creating balance of paymentsproblems.

Second, high and varying rates of inflation are incompatible with growth andemployment, in contrast to the assumptions of the Phillips curve, which posited

an inverse relationship between inflation and unemployment. Instead, theneoliberal consensus posits that inflation creates uncertainty over future pricelevels, high nominal interest rates, and falling financial asset values which alldampen business and spending activity, producing low levels of economicgrowth. Thus, growth and employment can only come about if inflation andinflationary expectations are brought under strict control. The larger implicationis that this is best achieved by governments committing themselves not to

intervene in the economy with expansionary policies, but instead to abjure short-term activism and set macroeconomic policy in a medium-term frame to containinflation.

A convergence in policy beliefs, or a policy consensus, is not the same as aconvergence in policy outcomes. Commitment to monetary rigour began in thecore EU countries, most importantly France and Italy, in 1976 and hardenedthroughout the EMS states in the 1980s, albeit with important but short-liveddeviations such as the Mitterrand U-turn (Ross et al., 1987). Yet the policies ofincreased commitment to price and exchange rate stability took time to pay offin terms of overall economic performance. The reason is simple: there is a lagbetween policy actions and policy outcomes, particularly those involvingsocietal expectations regarding inflation and policy credibility. While policy

beliefs and economic strategies began to converge in Europe in the late 1970s,economic convergence itself took longer. Nonetheless, it was this universal


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quest for price stability and its repercussions for monetary policy autonomy thatmade possible, as per Mundells conditions, the achievement of exchange ratestability in the EMS.

The new European neoliberal policy consensus differed from the embedded

liberalism of the Bretton Woods system in two key ways: it entailed a muchhigher level of conformity among nations in the goals and instruments ofmonetary policy; and it was based on more orthodox liberal principles than itspredecessor. Yet the policy shift was not driven by a purely ideologicalcommitment to these orthodox principals, but was instead a politically andhistorically contingent response by government leaders concerned about thedeteriorating position of their economies in an increasingly open and competi-

tive world economy. Although there are parallels, it differs substantially from theclassical liberalism of the gold standard era, because of the extent of both

democratic participation and government intervention in the present era.7

The evolution of European macroeconomic policy-making strategies isevident in Table 2, which very generally depicts the degree of divergence andconvergence, respectively, in the initial responses of the major states to the firstand second oil crises.

What caused this historic policy consensus? Its source can be found in threekey elements which, when translated through the domestic political arena and

7 Philip Cerny (1994) has made a somewhat similar argument more generally beyond the European case. Hecalls this policy consensus embedded financial orthodoxy.

Table 2: Macroeconomic Policy in Europe: Initial Responses to OPEC I and II

OPEC I Oil Shock of 1973

More Expansionary More Restrictive

Italy France Germany

Britain

OPEC II Oil Shock of 1979

More Expansionary More Restrictive

Germany

Britain

France (198183) France (1979-81; post-1983)

Italy

Source: Based on data on fiscal and monetary policies provided in OECD (various years), and Boltho (1984,

Table 1.1, p. 14).


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reinforced through institutionalized interactions within the EU, produced policychange. They are the perceived failure of Keynesianism in the wake of the firstoil crisis; the existence of an alternative policy paradigm, monetarism, to frameand legitimize the new economic policies; and finally, the example of German

success with a pragmatic version of monetarist policies. The increasinglyembedded institutional context of policy-making in the EC aided the collectivechange in beliefs about monetary policy and European exchange rate co-operation by providing a medium for the transmission of ideas. This wasparticularly true in terms of the processes of monetarist policy paradigmdiffusion and German policy emulation, in which interactions among thenational representatives in European fora proved quite important.

The perception of policy failure was the crucial first step in the process ofinterest redefinition among the EC states. During the four years following the

first oil crisis of 1973, policy-makers and their publics gradually and painfullycame to believe that the expansionist, activist policies which had worked so wellthroughout the Bretton Woods years no longer achieved national employmentand growth goals. The advent of stagflation (simultaneous inflation and reces-sion) and the puzzling breakdown of the historical relationship between unem-ployment and inflation, the Phillips curve, were central to this experience.Gradually, through a process of trial and error reflected most clearly in the erraticpath of policy-making of the European states during this time period, the

contours of their economies were reinterpreted and absorbed by policy-makers.This period of crisis and confusion corresponded with efforts at exchange ratestabilization in the European currency Snake, resulting in its demise as a EC-

wide institution.The timing of this policy change varied over the EC states from 1974 to 1977:

those countries such as Germany and the Benelux states where Keynesianismwas the least entrenched were the first to respond to stagflation with morerestrictive policies within a year of the first oil crisis; while Italy and France didnot set aside Keynesian reflationary strategies until several years of unsuccessful

attempts at demand management had elapsed. A decisive shift did occur,however, towards tight monetary policies attacking inflation before employmentand growth, clearly delineated in such programs as the 1976 Barre Plan in France,and the Andreotti monetary stabilization package of 197677 in Italy (McNama-ra, 1998).

Although the timing and details of the policy shift varied, common across the

European continent was the effect that the crises had on the domestic politicaldebate. The widespread perception of crisis created space for political leaders toimplement reforms without eliciting significant opposition from those groups insociety, such as labour, that traditionally opposed such austerity measures. Thisexperience of great strains, of frequent puzzlement amongst economic policy-


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makers and occasionally of anger and resentment reopened the debate on theworkings of the economy, while at the same time taking the wind out of thetraditional labour and union strategies of reflation and full-employment strate-gies (Dyson, 1982, p. 33). The inability of the Left to come up with effective

alternatives to monetary rigour meant orthodox views of the primacy of pricestability took hold more easily.

This perception of policy failure gave greater salience to the next crucial stepin the process that produced the neoliberal consensus: monetarist theory. In thiscontext of crisis, monetarism provided an alternative policy paradigm to guidethe movement away from Keynesianism, and its prescriptions appealed topolicy-makers by addressing both the changed economic environment and their

political needs. Monetarism offered policy-makers a coherent lens throughwhich to view their experiences with macroeconomic policy while offering a

legitimizing framework that made austerity reforms politically viable. In partic-ular, monetarists could posit an explanation for stagflation and the deteriorationof the Phillips curve relationship which implied that less, not more, governmentintervention was the cure for what ails the economy.

Monetarists accomplished this by rejecting the Phillips curve relationship asillusory, and arguing that rapid monetary expansion will lead directly to inflationwithout an increase in economic activity and employment (Friedman andSchwartz, 1963; Mayer, 1978). The monetarists argued that each economy has

a non-accelerating inflation rate of unemployment (NAIRU) which is structur-ally determined, and that any efforts to buy more employment by stimulatingthe economy and allowing for inflation cannot affect this rate. Indeed, such fine-

tuning policies will only bring on more stagflation, and governments shouldcease trying to shape the economy using the levers of monetary expansion andcontraction.

Indeed, setting goals, or monetary targets, for a stable, predictable annualincrease in the aggregate money supply, monetarists argued, is the best way toavoid inflation and provide an environment conducive to economic growth. The

widespread adoption of monetary targeting as a policy tool by the majority ofcontinental European governments by the mid-1970s indicated the influence ofthe monetarist framework on policy-making (OECD, 1979, p. 7; Joint EconomicCommittee, 1981).

It is important to note, however, that the governments of Europe followed apragmatic, not ideologically purist, type of monetarism. This is evident in the

fact that while monetary targets were widely adopted among the Europeangovernments, they were not the exclusive objective of monetary policy. Whereasmonetarist theory would argue that exchange rates should be allowed to float, asthe only appropriate policy target is the money supply, the European govern-ments viewed the fixing of their exchange rate to the German mark in the EMS


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as a way to reinforce the attempt to reduce inflation. The exception to thispragmatic monetarist stance in Europe was Britain, which most particularly inthe first years of Thatchers government, did adhere to the purist view ofmonetarism, as did the US Federal Reserve under Paul Volcker. Throughout the

early 1980s, Thatchers government targeted only the money supply and letexchange rates float. This purist orientation, combined with Britains differentstructure of trade, helps make sense of British exceptionalism when it comesto exchange rate co-operation in Europe.8

This pragmatic monetarism was promoted by experts in international organ-izations such as the OECD, in policy reports written for the EC, and in policycircles inside the national governments and perhaps most importantly for the

EMS project, by former economics professor and French Prime MinisterRaymond Barre. A largely monetarist viewpoint was articulated in an important

survey issued by the OECD, the McCracken Report, as it was in reports preparedin the mid-1970s by the OPTICA group of economic experts, invited by the ECto prepare an analysis of national economic policies and the prospects forrestarting the EMU project (OECD, 1977; Commission, 1976). Monetarist ideaswere diffused and reinforced by the increasingly frequent and congenial meet-ings among the European Central Bank governors, which had the effect ofencouraging a shared vision of monetary policy goals and instruments.9

The third key factor producing the policy consensus across Europe was

German policy success. The experience of the German Bundesbank withrestrictive, anti-inflationary policies offered a powerful and persuasive exampleof the merits of pragmatic monetarism for other EU central banks to emulate, and

strengthened the role of the D-mark as the anchor currency of the EMS. Whilemost of Europe was struggling with stagflation after the first oil crisis, WestGermany stood out as successful in managing its economy, particularly in termsof inflation and employment. Bundesbank officials were not hesitant to makeknown their views on the importance of price stability, proselytizing the meritsof restrictive monetary policy to their EU neighbours.

Germany was most clearly a preoccupation of France under President ValryGiscard dEstaing, but similar emulation processes of pragmatic monetarismwere under way in the other EU countries. Giscard dEstaing was highlymotivated to find a way for France to match the economic performance of

8Harmon (1994) argues that it was growing disillusionment in the mid-1980s with the ability of pure targetingof the money supply to reduce inflation that led senior British officials to begin to advocate joining the EMS.The British decision not to enter the fixed exchange rate agreement of the EMS also has been characterized

as la folie des grandeurs by one senior British government official. In his view, the British did not want toreduce the pounds symbolic sovereignty by linking it to the other European currencies (Interview, Brussels,October 1993).9Interviews, EC officials from DG II and the Committee of Central Bank Governors, Brussels (October 1991and May 1994). A related, but narrower theoretical conception of this process is found in the epistemiccommunity approach pioneered by Peter Haas (Haas, 1989, 1992).


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Germany, both for domestic electoral reasons and because of geopoliticalconcerns about France having equal weight to Germany in the EU. In hisspeeches and writings promoting the virtues of austerity programmes after 1976,Giscard dEstaing continually held Germany up as an example France should

emulate, extolling the virtues of price stability policies and warning of the needfor France to stay competitive with the German powerhouse (Giscard dEstaing,1981, p. 34; 1983, p. 124; Amouroux, 1986, pp. 2634; Story, 1981, p. 173).Notwithstanding some important deviations, the dynamics of the EMS through-out the 1980s reflected the process of policy emulation as Germany essentiallyset the monetary target for EMS participants and exchange rate stability in-creased. The combination of the German marks privileged position within the

exchange rate regime as the most credible currency and the special role ofGermany as source for domestic macroeconomic policy emulation are vital to

explaining the success of the EMS in the 1980s.Finally, these three sources of policy change were encouraged by institution-

alized interaction among national policy-makers within the European Commu-nity. The ministerial-level forum of the Council of Economic and FinanceMinisters (Ecofin) facilitated policy emulation and gave a platform for those inthe Commission who viewed Germanys pragmatic monetarism as an examplethat the Community should follow, as did the Committee of Central BankGovernors which has met regularly to oversee the operation of the fixed

exchange rate regime and co-ordinate policy. Gradually these groups developeda close rapport and an increasing influence on efforts at policy co-ordination andthe choice of national strategies, concurrent with the convergence of the national

policies around the German model in the 1980s. As one central banker comment-ed, the atmosphere in the Committee of Central Bank Governors and now in theEuropean Monetary Institute is very professional people do not come tomeetings with a distinctive national positions, but instead we all share a verycommon agreement on the correctness of a monetary policy model very close tothat of Germany.10While ideational changes occurred at the level of domestic

political actors, the institutions of the EC played an important role in fosteringthe consensus that underpinned the EMS by providing the medium within whichthe shared beliefs could be formulated and solidified.

V. The Future of European Monetary Integration

Capital mobility and policy ideas will continue to have a decisive influence onthe progress of European monetary integration. Within the EU, a single Europe-

10

The development of routinized interaction among the European central bankers was singled out as afacilitating factor for transnational learning by EC officials and members of the Committee of Central BankGovernors (Interviews, Brussels, October 1991 and May 1994; see also Gros and Thygesen, 1992, pp. 223; Thygesen, 1979, 20524).


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an currency solves the Unholy Trinity policy problem identified by Mundell bymerging together European monetary policies and eradicating exchange ratemovements. Outside the EU, the euro is likely to float against the other majorworld currencies, which will allow for the two alternative policy options of

capital mobility and monetary policy autonomy. Yet the neoliberal consensusnecessary to the sustainability of the EMS will continue to be crucial to thesuccess of EMU because general agreement on the goals and instruments ofmonetary policy is necessary if the European Central Bank (ECB) is to governeffectively and legitimately.

How strong is this policy consensus, and is it likely to continue? Since sharedbeliefs cannot be measured directly, it is difficult to answer this question

definitively. However, evaluating the three sources of the neoliberal consensus,policy failure, policy paradigm and Germany as a policy example, suggests that

the consensus may still hold in the area of monetary policy. More problematic,as will be discussed a moment, is what EMU signifies more broadly for thepolitical economies of Europe, in particular its demands on the fiscal politics ofthe EU states.

First, European policy-makers seem still to be influenced by the experienceof devastating inflation and the perception of Keynesian policy failure in the1970s. If the EMS offered a way to reinforce their domestic fight againstinflation, then EMU represents an even more ironclad way to lock in these

disciplining monetary policies, while at the same time providing Member Stateswith a seat at the policy-making table in the ECB (Sandholtz, 1993). While it isevident that unemployment, not inflation, is the key policy challenge facing

European governments today, it is not clear that monetary policy is viewed as apractical tool for addressing this challenge. The Amsterdam Treaty agreed to inJune 1997 notes that the primary responsibility for the design and delivery ofemployment policies rests at Member State level, but for the first time it formallyrecognizes that employment is a matter of common concern to the EU states andthat they should work together towards promoting jobs. However, it is not

macroeconomic policy that subsequent programmatic statements have promot-ed, but instead supply-side policies of labour market reform. Although the Treatystated that the objective of a high level of employment shall be taken intoconsideration in the formulation and implementation of Community policies andactivities (Art. 3), the statutes of the ECB make price stability the primary goalof monetary policy. The recent elections of more leftward- leaning governments,

most importantly the German Social Democrats, have produced new calls for theECB to broaden its mandate to growth and employment. However, given theproclivities of the ECB governors and its executive board, and the entrenchednature of the consensus on the virtues of price stability, it is not clear that this willoccur at any time in the near future.


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Second, monetarist principles and their advocates have long informed thedevelopment of EMU and continue to be a major influence on policy-making.The All Saints Day Manifesto of 1975, an early public call for the revival ofmonetary integration in Europe published in theEconomist, was essentially the

work of a group of economists sympathetic to monetarism, many of whom actedas advisers to the Commission during the 1970s (Economist, 1975). Many of theacademic economists working on the EMU issue a decade later, for examplepreparing the Commissions One Market, One Moneystudy and advising theDirectorate-General in charge of Economic and Financial Affairs, also workwithin this modified version of monetarism (Emerson et al., 1992). WimDuisenberg, the President of the ECB, has himself been noted for his emphasis

on monetary rigour as the Dutch Central Bank governor.However, monetarist theory has come under attack as a guide for policy

behaviour. The difficulties of accurately measuring the stock of money maketargeting of the money supply problematic, and uncertainty about the stability ofthe links between the money supply and inflation has damaged the reputationmonetarism enjoyed in the late 1970s and the first half of the 1980s (Judd andScadding, 1982;Economist, 1992, 1994). Certainly, the ECB faces distinctivetechnical challenges in monitoring the Euro-zone money supply. Yet Europesneoliberal consensus has never embodied a pure version of monetarism butinstead relied on its general principles and prescriptions while fashioning it to the

European context, a strategy which will no doubt continue. Equally important,the lack of any coherent alternative to monetarist principles has lessened theimpact of these critiques (Friedman, 1993).

Finally, the third factor contributing to the historic convergence of policypreferences, the emulation of the German model, is problematic but has not beensupplanted. Europeans continue to see Germany as an example for policyemulation, just as they did in the decade following the first oil crisis. This is inpart because Germanys economy is still regarded as most capable of achievinglong-term low inflation and export-led growth, despite the shocks of reunifica-

tion. Reflecting this view, the Maastricht Treatys provisions for the ECB arevery much modelled on the structure of the Bundesbank. Yet doubts have beenraised about the limits of policy emulation without true institutional convergencein the societal relationships which underpin economic policy-making, as mon-etary rigour may have higher costs in those national settings that do not mimicGerman neocorporatism (McNamara and Jones, 1996; Hall and Franzese, 1998).

German policy has been acknowledged by Alexandre Lamfalussy, the formerhead of the European Monetary Institute, no longer to be foolproof. Yet,Lamfalussy goes on to say that following the German example of targetting themonetary supply remains a better policy than the alternative which hecharacterizes as flying blind (Buerkle, 1993).


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The neoliberal consensus on monetary policy necessary for EMUs sustain-ability thus seems to be intact, but not immutable. Important political tensions,arising from the elite nature of the neoliberal consensus and its monetary notfiscal emphasis, seem likely to jeopardize EMUs future. While the neoliberal

policies of monetary rigour have had important effects on the economies ofEurope, they have not been subject to intensive mass political debate or electoralcontention, nor have they stimulated significant interest group politics. All thiscould soon change, however, for EMU both exacerbates and makes visible whatwas previously obscured, that is, the social costs of neoliberal reforms and thedemocratic deficit inherent in European integration more generally. A keystimulus for this is the fiscal retrenchment prompted by the EMU convergence

criteria and Growth and Stability Pact conditions.Although the convergence criteria were not met by the majority of EMU

states, the budget deficit targets of 3 per cent or less of GDP and public debts ofnot more than 60 per cent of GDP produced efforts at fiscal austerity, as well asa variety of one-off budgetary measures in the national capitals. Additionally,in an attempt to guarantee that fiscal discipline is maintained by the singlecurrency states, a Stability Pact was agreed to by the heads of state meeting inDublin in December 1996, with a system of penalties for states that run deficitsof more than 3 per cent of GDP after EMU begins. While it is unlikely that suchpenalties would ever be levied, the normative force of the agreement is likely to

be a deterrent to deficit spending.Several factors make this fiscal retrenchment more socially contentious andpolitically difficult than the monetary rigour required for stability in the EMS.

First, the neoliberal monetary co-operation of the EMS was itself eased by theuse of fiscal policy to cushion the effects of monetary rigour. While exchangerate stability increased in the 1980s, so did budget deficits throughout Europe,as unemployment benefits and public spending programmes were used topromote political and broader economic stability (Clark and Hallerberg, 1998;Garrett, 1998). Although increased taxes could help bridge the gap, they are by

no means a political certainty. Thus, it appears that the fiscal option is recedingat a time when it may be even more necessary given the institutionalization ofneoliberal monetary policies in EMU and continuing unemployment in Europe.

Second, the societal dynamics of fiscal retrenchment are fundamentallydifferent from those of the monetary realm. The analytic uncertainty andcollective action problems of monetary politics are not nearly as prevalent in

budget cutting, where the effects of pruning particular programmes are immedi-ately obvious to their constituencies, be they public workers, pensioners orbusinesses. The embedded liberalism of the welfare state is thus likely to bemore resilient than any other policy area in the face of increased pressures forreform (Pierson, 1996a), and the popular opposition to EMU could accelerate in


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the face of overburdened pension funds and declining social services. Thesanctioning of non-compliant states under a stability pact would heighten thevisibility of the linkage between austerity and monetary integration, possiblyfanning political discontent with European integration more generally. A non-

elected governing body of central bankers in a European central bank mayprovide the perfect scapegoat and political cover for further reforms, or it mayrenew criticisms about the lack of accountability in EU institutions. Aware ofthese issues, French officials prompted the creation of a new informal body offinance and economic ministers, the Euro-11, to act as a counterweight to thepolitical independence of the European Central Bank, but it does not have anystatutory power over the ECB and is resisted by those who believe that monetary

policy must be protected from politics and fiscal profligacy.The question is, to what degree EMU will force these issues out in the open

and subject them to overt political discourse within Europe over the next fewyears. A more politicized monetary integration process would be welcome,despite the complexities of this policy area, for EMUs outcome will greatlyimpact on the daily lives of the citizens of Europe for decades to come. Whilesome may strive to make the process of monetary integration one that isdisembedded, where economic motives and logic are separated from thebroader concerns of society, the relationship between the international economyand domestic political authority cannot be so easily divorced. EU governments

continue to have choices about the path of economic and monetary integration:although the capital constraint and the neoliberal policy consensus appear tohave painted them into a corner, it is important to remember that they have

themselves wielded the brushes that put them there.

VI. Conclusion

My account of the sources of European monetary integration has argued that thestructure of the international economy, namely capital mobility, shapes the

terrain within which politics unfold but the interpretation of that structure, orideational processes, dictate the crucial choice of policy content and form. Theimportance of shared beliefs in these cases should thus caution us against makingassumptions about the inevitability of EMU, or about the effects of globalizationon political outcomes more generally. Change of this sort is at present understud-ied: although we know that increasing financial interdependence is important,

we still do not fully understand the ways in which it interacts with domesticpolitics to shape foreign economic policies and consequently, relations amongstates. The theoretical claim that has been advanced here, that the progress ofEuropean monetary integration will not be understood by pitting ideas versusinterests as competing theoretical claims, but by exploring the inherent connec-


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KATHLEEN R. MCNAMARA

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