The monetary policy trilemma from the perspective of European integration

Abstract

Following the breakdown of the Bretton Woods agreement the international monetary system has operated based on floating exchange rate arrangements and free capital mobility. A most significant subsequent improvement has been the process of European monetary integration, from the institution of the European Monetary System to the Euro currency. The relationships between the short‐term interest rates of European Union (EU) countries and the United States suggest, that in the post‐Bretton Woods period the US dollar has held an important anchor currency role, while EU countries acquired considerable monetary policy independence. Further, the stronger relationships between the short‐term interest rates of EU countries and Germany may be viewed as a consequence of monetary unification. The econometric evidence provides important insights for the period following the adoption of the Euro, when European economies have in many instances been subject to heterogeneous shocks.