Journal of Common Market Studies September 1999

Vol. 37, No. 3 pp. 45576

Consensus and Constraint: Ideas and Capital Mobility in European Monetary Integration*

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 European 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 of ideational 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 Science Association, Washington, D.C., 2831 August 1997 and the Biannual Meeting of the European Community Studies 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 financial support; and to Sheri Berman, David Cameron, two anonymous reviewers and the editors for their comments.

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I. Introduction Long before the birth of the euro in 1999, monetary co-operation was a key concern of European political leaders. A series of fixed exchange rate agreements had been pursued by policy-makers in the post-war era as a way to encourage trade and investment by stabilizing currency fluctuations among the highly open economies of the common European market. Monetary co-operation 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 its initial 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. The creation 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 to EMU. Although European exchange rates were stabilized in the first decades of the post-war era within the Bretton Woods international monetary system, the European-only currency Snake effectively collapsed after a few years of operation in the early 1970s. Yet the next European regime, the European Monetary System (EMS) begun in 1979, proved surprisingly durable through the 1980s and 1990s. Indeed, the success of the EMS was a major impetus for the single currency ambitions of the Maastricht Treaty. This mixed record constitutes an empirical puzzle for those studying the progress of European integration: its resolution may shed light on the future path of EMU, as well as helping explain more 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 across the majority of the European governments beginning in the mid-1970s and solidifying in the 1980s. A neoliberal policy consensus that elevated the pursuit of low inflation over growth or employment replaced the Keynesian beliefs of political elites, ultimately contributing to a downward convergence in inflation rates across Europe. This monetary policy consensus redefined state interests in co-operation, underpinned stability in the EMS, and induced political leaders to accept the domestic policy adjustments needed to stay within the system. Though this monetarist-influenced consensus was by no means unwavering or monolithic and is showing signs of wear, it represented a clear break with the divergent economic policy paths and diverse priorities of Keynesianism as practised by the European states during the Bretton Woods era. For students of politics, this European reorientation is particularly notable because it occurred across most of the EU states, regardless of political party or domestic institutional structure.
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Policy consensus has been noted by others as key to the progress of European integration (Sandholtz and Zysman, 1989; Pauly, 199192; Moravcsik, 1991; Sandholtz, 1993).1 Yet a series of important questions raised by this contention remain unanswered, particularly in the monetary realm. Why was the neoliberal policy consensus crucial to the success of the EMS? Where did it come from, and what were its political foundations? What might cause cracks in these foundations? And if this neoliberal policy consensus is so important, how were the European states able to stabilize their currencies within the earlier Bretton Woods system before such a consensus developed in the 1970s? To answer these questions, I explore the interaction between a changing international economy, one in which capital flows have increased exponentially, and the domestic policy-making process, particularly political leaders beliefs about macroeconomic strategy. I argue that capital mobility plays a critical role in determining the conditions under which international monetary agreements can be sustained (Cohen, 1993; Andrews, 1994; Webb, 1995; Pauly, 1997). Such structural features do not dictate policy choice, however. Political leaders ideas, defined here as shared normative and causal beliefs, are crucial to explaining whether states choose to take the steps necessary to meet those conditions (Hall, 1992, 1993; Sikkink, 1991; Goldstein, 1993). Political actors use these ideas to evaluate the costs and benefits of monetary co-operation and chart a policy course. Policy-makers draw on these ideas to formulate answers to questions of values and strategies: what should the goals of monetary policy be, and what instruments can be used in pursuit of those goals? The answers will vary significantly over time and place, as human agency, in the form of interpretation, interacts with the structural features of capital mobility to define national interests 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 with other actors, and they survive implementation into policy only if they are politically salient (Risse-Kappen, 1994). Thus, to explain why neoliberal economic policy ideas triumphed within the political arena, making European monetary co-operation more likely, I develop a template for understanding why certain ideas become dominant at a given historical point, while others are put aside. A process of perceived policy failure, policy paradigm innovation, and policy emulation unfolded among the states of the EU, replacing Keynesianism with 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 the many states in the defunct Bretton Woods system, such as those of the United States and Japan, which moved to floating exchange rates and less stringent
1

In particular, Sandholtz (1993) is notable for pointing out the nature and importance of the monetary policy consensus for the development of EMU.
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monetary policies. Indeed, this template of ideational change indicates not the inevitability of convergence, but instead its contingency. The elite nature of this process also reveals the weakness of the political basis for EMU, which has contributed 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, wellaccepted macroeconomic model for understanding the implications of capital mobility for monetary co-operation and then apply it to the historical experience of post-war Europe with fixed exchange rate regimes. Second, the role of ideas in monetary policy-making is analysed and their impact on European monetary integration is described. Placing my arguments within a larger theoretical and historical perspective, the final section considers the future of European monetary union. II. Capital Constraints: Mundells Holy Trinity Changes in the world economy have reconfigured the set of options governments face when pursuing monetary co-operation. A variant of the Mundell-Fleming model, a central framework in modern macroeconomic theory which has become well accepted among policy-makers today, is a useful way to describe why this was so. This theoretical proposition was formally known as Mundells assignment problem, but is often referred to as the Holy or Unholy Trinity (Mundell, 1960; Cohen, 1977; Rose, 1994). It sketches out the interaction between domestic policy choices and multilateral exchange rate co-operation as capital markets become increasingly integrated and the volume of capital flows rises. According to this proposition, policy-makers can choose only two of the three following policy options at any one time: free capital flows; a fixed exchange rate; and monetary policy autonomy. Thus, if a government wishes to keep 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 options states will choose at any point in time. However, it merely outlines the logical incompatibility of having all three simultaneously. It also provides a useful framework for interpreting the broader history of international monetary regimes, as shown in Table 1.
2 In contrast, fiscal policy under the broader Mundell-Fleming model is predicted to be more effective with capital 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 their fiscal 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 Capital Mobility Bretton Woods (194571) European Currency Snake (197278) European Monetary System (1979present) No (Low levels) Yes (Rising) Yes (High) Economic Policy Options Autonomous Fixed Monetary Exchange Policy Rates/Co-operation Yes Yes

Yes

No (attempted, but failed) Yes

No

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 the Bretton Woods international monetary regime as a baseline. The Bretton Woods system, which included, among others, all the states of what is today the EU, was created in 1945 and lasted until 1971.4 Responding to domestic political necessities and supported by American hegemony, Bretton Woods was set up by British and American policy-makers so as to allow policy autonomy to coexist with fixed exchange rates in what John Ruggie has called the compromise of embedded liberalism (Ruggie, 1982). Embedded liberalism refers to the idea that Bretton Woods was liberal in the sense of encouraging international economic transactions, but its liberalism was tempered by, or embedded within, a larger social context of goals beyond economic efficiency, in contrast to the laissez-faire approach of the nineteenth century (Polanyi, 1944). But the only way to ensure that this intention could be realized was to limit capital movements within the system; indeed capital controls were a major preoccupation of John Maynard Keynes when designing Bretton Woods (Ikenberry, 1993). Thus, autonomous monetary policy, fixed rates and low levels of capital mobility marked 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. 4 Bordo and Eichengreen (1993) provide an excellent overview of the creation, operation and collapse of the Bretton Woods system.
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The resurgence in international capital mobility in the late 1960s and early 1970s, aided and abetted in part by government action or inaction (Helleiner, 1994) therefore had serious consequences for the European governments efforts to 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 and mobility of capital flows were beginning to make the pursuit of fixed exchange rates conditional upon the surrender of monetary policy autonomy. In other words, the domestically-driven compromise of embedded liberalism, which allowed states to expand and contract the national money supply in the quest for full employment and economic growth, could no longer form a basis for multilateral monetary co-operation within a fixed exchange rate regime. As per Mundells axiom, capital flows were simply becoming too high to continue to coexist with fixed rates and policy autonomy. As will be discussed further below, many of the European governments did continue to use autonomous, Keynesian macroeconomic policies oriented to the particular needs of their domestic polities throughout the Snake period, making the maintenance of fixed exchange rates extremely difficult. By the time of the creation of the EMS in 1979, however, key European governments, most importantly France, had begun to eschew domestic policy autonomy, and this domestic political shift, while not complete, formed the basis for the achievement of relatively fixed exchange rates in the EMS.5 Mundells framework helps make sense of how capital mobility interacts with national monetary policy-making and monetary co-operation. Yet it only sets the structural conditions under which governments decide on policy (Andrews, 1994). It does not tell us what choice governments will make when faced with these three incompatible policy goals. Although costly, governments can choose to limit capital mobility in order to regain some policy autonomy and stable exchange rates. Governments also can choose to float their rates rather than 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 of an international fixed exchange rate regime has not proved incompatible with rapidly increasing global trade and investment. Left unexplained in this structural approach, therefore, is how governments calculate the trade-offs inherent in economic policy-making and, in the European case, why governments were prepared to abandon embedded liberalism in the area of monetary policy.

For data in support of the increasing degree of nominal exchange rate stability over this period, see McNamara (1998) Tables 1 and 2. Of course there have been episodes of currency crises as well, precipitated both by political uncertainties and the imperfect convergence in the economies of the EU under conditions of 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 to exchange 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 and the trade-offs it presents with an understanding of how states interests in monetary co-operation have been constructed and transformed over the post-war period. 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 contrast to the Snake. National elites ideas about the nature of the domestic economy and the goals and instruments of monetary policy directly informed their positions on European monetary integration. While the international economic environment is important, as Emanuel Adler has pointed out, the environment does not instruct policy-makers, it challenges them (Adler, 1991). In the macroeconomic realm, policy-makers responses to those challenges cannot be understood without attention to ideational factors, in particular, the policy-makers shared normative and causal beliefs about the nature of monetary policy. Much of the political science literature tends to assume that interests can be determined from an actors position in the economy or within the prevailing political order. Actors simply know what is in their interests and act on that knowledge; interests are given or exogenous in many accounts. But other theorists have argued that interpretations of the external world, be it market structures or power politics, are not unproblematic. Actors must rely on conceptual frameworks to make sense of the world around them, and their place within it. The most fundamental critique of the rationalist approach is from the social constructivist school (Wendt, 1992; Laffey and Weldes, 1997). However, others have elected to critique the rationalist approach from within, by using positivist methods to study the role of ideas (Sikkink, 1991; Goldstein, 1993). That is the approach taken here. Ideas are critical in the monetary realm because of continuing uncertainty over the fundamental workings of the economy, the difficulties of collecting and interpreting signals from macroeconomic data about the effects of policy, and the lack of agreement over what constitutes correct macroeconomic policy. Conceptual uncertainty about cause and effect relationships in the economy includes ambiguity over the micro-level distributional effects of exchange rate and monetary co-operation. As Alberto Giovannini has argued, there is little agreement within the economics profession on a benchmark model for analysing the distributional effects of alternative monetary regimes. His analysis of three existing models leads him to conclude that economic interests in favor of a fixed currency versus flexible exchange rates are not easily identifiable and that 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 economic conditions at a particular point in time (Giovannini, 1995, p. 312). In a more comprehensive critique of the limitations of the field, Paul Krugman points out that the microeconomic foundations of international monetary affairs comprise one of the weakest areas in the discipline of economics. Krugman writes that while we have some suggestive notions, what we do not have, however, is anything we can properly call a model of the benefits of fixed rates and common currencies (Krugman, 1993, p. 22). This uncertainty translates into inaction on the part of domestic interest groups, 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 have expressed 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 their significant trade integration. Yet beyond this general policy preference, national policy-makers are not subject to significant lobbying on exchange rate or monetary issues. Uncertainty, and the dilemmas of collective action it produces, tend to keep interest group activity to a minimum on monetary issues, as does the relative institutional insulation of the national treasury and central bank officials from direct societal pressures.6 In sum, economic structure alone is indeterminate 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 through social interaction, are thus fundamental to monetary politics (Odell, 1982; Oye, 1986; Hall, 1992, 1993). These beliefs serve as a crucial guide for government officials attempting to analyse the complex technical relationships that make up the economy, providing them with a meansend knowledge that allows for the development of economic policies and a lens with which to judge their relative merits. In other words, these policy ideas can function like flashlights, guiding policy-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 involves normative contests in the case of monetary integration, over the balance between the state and the market. Neither does the change in ideas occur in isolation, but is the product of interactions within formal and informal multilateral institutions (Krasner, 1983; Haas, 1989, 1992; Hall, 1989; Pierson, 1996b).

For 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 cooperation 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 creation of the EMS in 1979, the majority of EC states ceased following domesticallyoriented, activist monetary policies. The neoliberal policy consensus at the core of 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 the subsequent revival of the EMU project. These neoliberal beliefs, held by key political leaders as described in more detail 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 will instead produce inflation and inflationary expectations and are thus counterproductive. Such policies will also prompt financial markets to drive down the exchange rate, further worsening inflation and creating balance of payments problems. Second, high and varying rates of inflation are incompatible with growth and employment, in contrast to the assumptions of the Phillips curve, which posited an inverse relationship between inflation and unemployment. Instead, the neoliberal consensus posits that inflation creates uncertainty over future price levels, high nominal interest rates, and falling financial asset values which all dampen business and spending activity, producing low levels of economic growth. Thus, growth and employment can only come about if inflation and inflationary expectations are brought under strict control. The larger implication is that this is best achieved by governments committing themselves not to intervene in the economy with expansionary policies, but instead to abjure shortterm activism and set macroeconomic policy in a medium-term frame to contain inflation. A convergence in policy beliefs, or a policy consensus, is not the same as a convergence in policy outcomes. Commitment to monetary rigour began in the core EU countries, most importantly France and Italy, in 1976 and hardened throughout the EMS states in the 1980s, albeit with important but short-lived deviations such as the Mitterrand U-turn (Ross et al., 1987). Yet the policies of increased commitment to price and exchange rate stability took time to pay off in terms of overall economic performance. The reason is simple: there is a lag between policy actions and policy outcomes, particularly those involving societal 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 that made possible, as per Mundells conditions, the achievement of exchange rate stability 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 much higher level of conformity among nations in the goals and instruments of monetary policy; and it was based on more orthodox liberal principles than its predecessor. Yet the policy shift was not driven by a purely ideological commitment to these orthodox principals, but was instead a politically and historically contingent response by government leaders concerned about the deteriorating position of their economies in an increasingly open and competitive world economy. Although there are parallels, it differs substantially from the classical 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 is evident in Table 2, which very generally depicts the degree of divergence and convergence, respectively, in the initial responses of the major states to the first and second oil crises. What caused this historic policy consensus? Its source can be found in three key elements which, when translated through the domestic political arena and
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).
7

Philip Cerny (1994) has made a somewhat similar argument more generally beyond the European case. He calls this policy consensus embedded financial orthodoxy.
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reinforced through institutionalized interactions within the EU, produced policy change. They are the perceived failure of Keynesianism in the wake of the first oil crisis; the existence of an alternative policy paradigm, monetarism, to frame and legitimize the new economic policies; and finally, the example of German success with a pragmatic version of monetarist policies. The increasingly embedded institutional context of policy-making in the EC aided the collective change in beliefs about monetary policy and European exchange rate cooperation by providing a medium for the transmission of ideas. This was particularly true in terms of the processes of monetarist policy paradigm diffusion and German policy emulation, in which interactions among the national representatives in European fora proved quite important. The perception of policy failure was the crucial first step in the process of interest redefinition among the EC states. During the four years following the first oil crisis of 1973, policy-makers and their publics gradually and painfully came to believe that the expansionist, activist policies which had worked so well throughout the Bretton Woods years no longer achieved national employment and growth goals. The advent of stagflation (simultaneous inflation and recession) and the puzzling breakdown of the historical relationship between unemployment and inflation, the Phillips curve, were central to this experience. Gradually, through a process of trial and error reflected most clearly in the erratic path 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 rate stabilization in the European currency Snake, resulting in its demise as a ECwide 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 Keynesianism was the least entrenched were the first to respond to stagflation with more restrictive policies within a year of the first oil crisis; while Italy and France did not 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 employment and growth, clearly delineated in such programs as the 1976 Barre Plan in France, and the Andreotti monetary stabilization package of 197677 in Italy (McNamara, 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 political debate. The widespread perception of crisis created space for political leaders to implement reforms without eliciting significant opposition from those groups in society, such as labour, that traditionally opposed such austerity measures. This experience of great strains, of frequent puzzlement amongst economic policy Blackwell Publishers Ltd 1999

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makers and occasionally of anger and resentment reopened the debate on the workings of the economy, while at the same time taking the wind out of the traditional labour and union strategies of reflation and full-employment strategies (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 price stability took hold more easily. This perception of policy failure gave greater salience to the next crucial step in the process that produced the neoliberal consensus: monetarist theory. In this context of crisis, monetarism provided an alternative policy paradigm to guide the movement away from Keynesianism, and its prescriptions appealed to policy-makers by addressing both the changed economic environment and their political needs. Monetarism offered policy-makers a coherent lens through which to view their experiences with macroeconomic policy while offering a legitimizing framework that made austerity reforms politically viable. In particular, monetarists could posit an explanation for stagflation and the deterioration of the Phillips curve relationship which implied that less, not more, government intervention was the cure for what ails the economy. Monetarists accomplished this by rejecting the Phillips curve relationship as illusory, and arguing that rapid monetary expansion will lead directly to inflation without an increase in economic activity and employment (Friedman and Schwartz, 1963; Mayer, 1978). The monetarists argued that each economy has a non-accelerating inflation rate of unemployment (NAIRU) which is structurally determined, and that any efforts to buy more employment by stimulating the economy and allowing for inflation cannot affect this rate. Indeed, such finetuning policies will only bring on more stagflation, and governments should cease trying to shape the economy using the levers of monetary expansion and contraction. Indeed, setting goals, or monetary targets, for a stable, predictable annual increase in the aggregate money supply, monetarists argued, is the best way to avoid inflation and provide an environment conducive to economic growth. The widespread adoption of monetary targeting as a policy tool by the majority of continental European governments by the mid-1970s indicated the influence of the monetarist framework on policy-making (OECD, 1979, p. 7; Joint Economic Committee, 1981). It is important to note, however, that the governments of Europe followed a pragmatic, not ideologically purist, type of monetarism. This is evident in the fact that while monetary targets were widely adopted among the European governments, they were not the exclusive objective of monetary policy. Whereas monetarist theory would argue that exchange rates should be allowed to float, as the only appropriate policy target is the money supply, the European governments 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 this pragmatic monetarist stance in Europe was Britain, which most particularly in the first years of Thatchers government, did adhere to the purist view of monetarism, as did the US Federal Reserve under Paul Volcker. Throughout the early 1980s, Thatchers government targeted only the money supply and let exchange rates float. This purist orientation, combined with Britains different structure of trade, helps make sense of British exceptionalism when it comes to exchange rate co-operation in Europe.8 This pragmatic monetarism was promoted by experts in international organizations such as the OECD, in policy reports written for the EC, and in policy circles inside the national governments and perhaps most importantly for the EMS project, by former economics professor and French Prime Minister Raymond Barre. A largely monetarist viewpoint was articulated in an important survey issued by the OECD, the McCracken Report, as it was in reports prepared in the mid-1970s by the OPTICA group of economic experts, invited by the EC to prepare an analysis of national economic policies and the prospects for restarting the EMU project (OECD, 1977; Commission, 1976). Monetarist ideas were diffused and reinforced by the increasingly frequent and congenial meetings among the European Central Bank governors, which had the effect of encouraging 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 with restrictive, anti-inflationary policies offered a powerful and persuasive example of 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. While most of Europe was struggling with stagflation after the first oil crisis, West Germany stood out as successful in managing its economy, particularly in terms of inflation and employment. Bundesbank officials were not hesitant to make known their views on the importance of price stability, proselytizing the merits of restrictive monetary policy to their EU neighbours. Germany was most clearly a preoccupation of France under President Valry Giscard dEstaing, but similar emulation processes of pragmatic monetarism were under way in the other EU countries. Giscard dEstaing was highly motivated to find a way for France to match the economic performance of
8

Harmon (1994) argues that it was growing disillusionment in the mid-1980s with the ability of pure targeting of 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 to reduce the pounds symbolic sovereignty by linking it to the other European currencies (Interview, Brussels, October 1993). 9 Interviews, EC officials from DG II and the Committee of Central Bank Governors, Brussels (October 1991 and May 1994). A related, but narrower theoretical conception of this process is found in the epistemic community approach pioneered by Peter Haas (Haas, 1989, 1992).
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Germany, both for domestic electoral reasons and because of geopolitical concerns about France having equal weight to Germany in the EU. In his speeches 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 need for 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 throughout the 1980s reflected the process of policy emulation as Germany essentially set the monetary target for EMS participants and exchange rate stability increased. The combination of the German marks privileged position within the exchange rate regime as the most credible currency and the special role of Germany 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 institutionalized interaction among national policy-makers within the European Community. The ministerial-level forum of the Council of Economic and Finance Ministers (Ecofin) facilitated policy emulation and gave a platform for those in the Commission who viewed Germanys pragmatic monetarism as an example that the Community should follow, as did the Committee of Central Bank Governors which has met regularly to oversee the operation of the fixed exchange rate regime and co-ordinate policy. Gradually these groups developed a close rapport and an increasing influence on efforts at policy co-ordination and the choice of national strategies, concurrent with the convergence of the national policies around the German model in the 1980s. As one central banker commented, the atmosphere in the Committee of Central Bank Governors and now in the European Monetary Institute is very professional people do not come to meetings with a distinctive national positions, but instead we all share a very common agreement on the correctness of a monetary policy model very close to that of Germany.10 While ideational changes occurred at the level of domestic political actors, the institutions of the EC played an important role in fostering the consensus that underpinned the EMS by providing the medium within which the 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 on the progress of European monetary integration. Within the EU, a single Europe10 The development of routinized interaction among the European central bankers was singled out as a facilitating factor for transnational learning by EC officials and members of the Committee of Central Bank Governors (Interviews, Brussels, October 1991 and May 1994; see also Gros and Thygesen, 1992, pp. 22 3; Thygesen, 1979, 20524).

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an currency solves the Unholy Trinity policy problem identified by Mundell by merging together European monetary policies and eradicating exchange rate movements. Outside the EU, the euro is likely to float against the other major world currencies, which will allow for the two alternative policy options of capital mobility and monetary policy autonomy. Yet the neoliberal consensus necessary to the sustainability of the EMS will continue to be crucial to the success of EMU because general agreement on the goals and instruments of monetary policy is necessary if the European Central Bank (ECB) is to govern effectively and legitimately. How strong is this policy consensus, and is it likely to continue? Since shared beliefs 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 the political economies of Europe, in particular its demands on the fiscal politics of the EU states. First, European policy-makers seem still to be influenced by the experience of devastating inflation and the perception of Keynesian policy failure in the 1970s. If the EMS offered a way to reinforce their domestic fight against inflation, then EMU represents an even more ironclad way to lock in these disciplining monetary policies, while at the same time providing Member States with a seat at the policy-making table in the ECB (Sandholtz, 1993). While it is evident that unemployment, not inflation, is the key policy challenge facing European governments today, it is not clear that monetary policy is viewed as a practical tool for addressing this challenge. The Amsterdam Treaty agreed to in June 1997 notes that the primary responsibility for the design and delivery of employment policies rests at Member State level, but for the first time it formally recognizes that employment is a matter of common concern to the EU states and that they should work together towards promoting jobs. However, it is not macroeconomic policy that subsequent programmatic statements have promoted, but instead supply-side policies of labour market reform. Although the Treaty stated that the objective of a high level of employment shall be taken into consideration in the formulation and implementation of Community policies and activities (Art. 3), the statutes of the ECB make price stability the primary goal of monetary policy. The recent elections of more leftward- leaning governments, most importantly the German Social Democrats, have produced new calls for the ECB to broaden its mandate to growth and employment. However, given the proclivities of the ECB governors and its executive board, and the entrenched nature of the consensus on the virtues of price stability, it is not clear that this will occur at any time in the near future.
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Second, monetarist principles and their advocates have long informed the development 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 of monetary integration in Europe published in the Economist, was essentially the work of a group of economists sympathetic to monetarism, many of whom acted as advisers to the Commission during the 1970s (Economist, 1975). Many of the academic economists working on the EMU issue a decade later, for example preparing the Commissions One Market, One Money study and advising the Directorate-General in charge of Economic and Financial Affairs, also work within this modified version of monetarism (Emerson et al., 1992). Wim Duisenberg, 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 make targeting of the money supply problematic, and uncertainty about the stability of the links between the money supply and inflation has damaged the reputation monetarism enjoyed in the late 1970s and the first half of the 1980s (Judd and Scadding, 1982; Economist, 1992, 1994). Certainly, the ECB faces distinctive technical challenges in monitoring the Euro-zone money supply. Yet Europes neoliberal consensus has never embodied a pure version of monetarism but instead 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 the impact of these critiques (Friedman, 1993). Finally, the third factor contributing to the historic convergence of policy preferences, the emulation of the German model, is problematic but has not been supplanted. Europeans continue to see Germany as an example for policy emulation, just as they did in the decade following the first oil crisis. This is in part because Germanys economy is still regarded as most capable of achieving long-term low inflation and export-led growth, despite the shocks of reunification. Reflecting this view, the Maastricht Treatys provisions for the ECB are very much modelled on the structure of the Bundesbank. Yet doubts have been raised about the limits of policy emulation without true institutional convergence in the societal relationships which underpin economic policy-making, as monetary rigour may have higher costs in those national settings that do not mimic German neocorporatism (McNamara and Jones, 1996; Hall and Franzese, 1998). German policy has been acknowledged by Alexandre Lamfalussy, the former head of the European Monetary Institute, no longer to be foolproof. Yet, Lamfalussy goes on to say that following the German example of targetting the monetary supply remains a better policy than the alternative which he characterizes as flying blind (Buerkle, 1993).
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The neoliberal consensus on monetary policy necessary for EMUs sustainability thus seems to be intact, but not immutable. Important political tensions, arising from the elite nature of the neoliberal consensus and its monetary not fiscal emphasis, seem likely to jeopardize EMUs future. While the neoliberal policies of monetary rigour have had important effects on the economies of Europe, they have not been subject to intensive mass political debate or electoral contention, nor have they stimulated significant interest group politics. All this could soon change, however, for EMU both exacerbates and makes visible what was previously obscured, that is, the social costs of neoliberal reforms and the democratic deficit inherent in European integration more generally. A key stimulus 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 of not more than 60 per cent of GDP produced efforts at fiscal austerity, as well as a variety of one-off budgetary measures in the national capitals. Additionally, in an attempt to guarantee that fiscal discipline is maintained by the single currency states, a Stability Pact was agreed to by the heads of state meeting in Dublin in December 1996, with a system of penalties for states that run deficits of more than 3 per cent of GDP after EMU begins. While it is unlikely that such penalties 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 and politically difficult than the monetary rigour required for stability in the EMS. First, the neoliberal monetary co-operation of the EMS was itself eased by the use of fiscal policy to cushion the effects of monetary rigour. While exchange rate stability increased in the 1980s, so did budget deficits throughout Europe, as unemployment benefits and public spending programmes were used to promote 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 receding at a time when it may be even more necessary given the institutionalization of neoliberal monetary policies in EMU and continuing unemployment in Europe. Second, the societal dynamics of fiscal retrenchment are fundamentally different from those of the monetary realm. The analytic uncertainty and collective action problems of monetary politics are not nearly as prevalent in budget cutting, where the effects of pruning particular programmes are immediately obvious to their constituencies, be they public workers, pensioners or businesses. The embedded liberalism of the welfare state is thus likely to be more resilient than any other policy area in the face of increased pressures for reform (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. The sanctioning of non-compliant states under a stability pact would heighten the visibility of the linkage between austerity and monetary integration, possibly fanning political discontent with European integration more generally. A nonelected governing body of central bankers in a European central bank may provide the perfect scapegoat and political cover for further reforms, or it may renew criticisms about the lack of accountability in EU institutions. Aware of these issues, French officials prompted the creation of a new informal body of finance and economic ministers, the Euro-11, to act as a counterweight to the political independence of the European Central Bank, but it does not have any statutory 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 few years. A more politicized monetary integration process would be welcome, despite the complexities of this policy area, for EMUs outcome will greatly impact on the daily lives of the citizens of Europe for decades to come. While some may strive to make the process of monetary integration one that is disembedded, where economic motives and logic are separated from the broader concerns of society, the relationship between the international economy and 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 to have 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 the structure of the international economy, namely capital mobility, shapes the terrain within which politics unfold but the interpretation of that structure, or ideational processes, dictate the crucial choice of policy content and form. The importance of shared beliefs in these cases should thus caution us against making assumptions about the inevitability of EMU, or about the effects of globalization on political outcomes more generally. Change of this sort is at present understudied: although we know that increasing financial interdependence is important, we still do not fully understand the ways in which it interacts with domestic politics to shape foreign economic policies and consequently, relations among states. The theoretical claim that has been advanced here, that the progress of European monetary integration will not be understood by pitting ideas versus interests as competing theoretical claims, but by exploring the inherent connec Blackwell Publishers Ltd 1999

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tion between the two, supports the view that governments continue to have choices in their policies. While a range of economic constraints are created by capital mobility, a deterministic view of the political effects of globalization is unfounded. Instead, the process by which actors in the EU have come to redefine their interests is a historically dependent one which relies on policy-makers shared beliefs to guide the path of European integration.
Correspondence Kathleen R. McNamara Assistant Professor of Politics and International Affairs Center of International Studies, Princeton University Princeton, NJ 08544, USA email: mcnamara@princeton.edu

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