1  Nout Wellink, ‘The Role of National Central Banks within the Europeans System of Central Banks: The Example of De Nederlandsche Bank’, 30th Economics Conference, Oesterreichische Nationalbank, June 13 – 14, 2002. 2  BIS Review 46/2002  This would not, however, represent much of a change because already today the Bank has only limited autonomy in the conduct of monetary policy. As far as the transition to the euro is concerned, therefore, the path that Malta should follow seems fairly straightforward, given the starting point of the existing exchange rate regime. Today, the basket consists of the euro, the US dollar and sterling, with weights of around 52%, 26% and 22%, respectively. There is no fluctuation band. The peg is backed by official external reserves, which have comfortably exceeded the monetary base over the years and are equivalent to a fifth of broad money. The first step would be to increase the weight of the euro in the currency basket at the expense of either or both of the other component currencies. If the United Kingdom were to join EMU, this would automatically raise the proportion of the euro in the currency basket, making Maltese entry into ERM II that much easier. On accession, the timing for joining ERM II, as well as technical questions relating to the entry level and the fluctuation band will be up for discussion. If the Maltese lira were to join ERM II with the normal fluctuation band of ±15%, this would inject more flexibility into the system.
The exchange rate would be able to move in response to the balance of payments, allowing monetary policy some latitude in reacting to domestic economic developments. In this framework, the real exchange rate appreciation that is a corollary of economic convergence could take place via nominal exchange rate appreciation. However, the introduction of a relatively wide fluctuation band could lead to unprecedented exchange rate volatility. In turn, this could jeopardise the Bank’s price stability objective. It may, therefore, be preferable to enter ERM II without a fluctuation band at all. This exchange rate strategy of course implies that the burden of adjustment to shocks will have to be borne by the real economy. In the first instance this means pursuing a prudent fiscal policy. The current aim of fiscal policy is indeed to reduce the deficit to GDP ratio to around 2.5% by 2004, from 5.3% last year and over 10% in the late 1990s. By restraining domestic absorption, a tighter fiscal stance will enhance the credibility of the exchange rate peg. Moreover, a smaller borrowing requirement will also free up resources for the private sector and contain upward pressure on interest rates, thereby stimulating economic growth. Finally, bringing the budget deficit closer to balance will then give fiscal policy the leeway it lacks today to respond to adverse shocks or cyclical downturns. The response to such disturbances will also depend on the degree of flexibility in the economy as a whole.