This is a book about sound public finance at the national, regional and city levels. In a time of deepening decentralisation, the quality of budgetary decision-making by regions and cities shapes increasingly the overall fiscal performance of individual nations and groups thereof, such as the European Union.

World-wide economic growth benefits from policy stability but often decision-makers at all levels of government neglect the credibility of their commitments towards policy stability. Hence, this chapter focuses on the efficiency merits of combining stability policies at home with earning credibility abroad. This point, recognised as crucial in the international financial architecture debate, owes a great deal to the experience of the European Monetary Union (EMU). Nevertheless, the portability of the message to Latin America, Asia or Africa is a matter of dispute, as discussed in chapter 7 below.

The text is slightly updated from the version presented by one of the authors, under the title A European Monetary Union of Nations, Regions and Cities, at a conference sponsored by Banca di Roma, Fiat and Mediocredito Centrale on Mezzogiorno, Europe Objective Integration, held in Palermo on June 28, 1996 and, under the title: One Market, One Money Consequences for the Regions), at the Colloques de Divonne sponsored by the Fondation pour une Histoire de la Civilisation Européenne, held on March 15, 1996).

The presentation reflects the policymaking experience of the Finance Minister who devised the strategy of bringing the participation of Portugal in international financial markets to the benefit of residents in 1991-93, making the Republic "Borrower of the Year" according to Euromoney. This is described in Macedo et al (1999), which includes tests of the credibility of the regime change brought about by joining the European Monetary System (EMS). In turn, the experience of the chair of the parliamentary committee of European Affairs in 1994-95, described in Macedo (1995), helped support the view about positive variable geometry or " reinforced cooperation" as it is called in the Nice treaty (Macedo 2001b and CEPR 1996 and 2001).

But the chapter also reflects the same author's subsequent consulting experience with the similar strategy followed by the Autonomous Region of Azores in 1996-97. This is the only Portuguese subnational entity to have the international rating of A2, provided by Moody's Investors Services at one notch below the sovereign ceiling at the time. Azores issued two floating rate notes for 150 million dollars, due 2006, and Credit Suisse First Boston was joint bookrunner in both. Financial markets accepted the new borrower well, in spite of the unravelling of the Asian financial crisis at the time of the second issue in late 1997.

In the oral tradition of Southern European monetary history, financial and political stability, defined respectively as a convertible currency and a parliamentary democracy, are thought to be negatively correlated. Each nation - and each region or city within it - must strive to depart from this unfortunate correlation. Nevertheless, the Euro may help European nations, regions and cities earn international credibility. If the successive revision of the treaty on European Union reinforce cohesion whilst converging towards a single currency, this will happen at the changing centres and peripheries of the union, North, South, West and East.

The inter-governmental nature of the treaty revisions aside, greater parliamentary involvement in European affairs is a signal of the national effort to make the interaction between financial and political stability positive rather than negative - and of the support of regions and cities to convergence and cohesion. For example, Assembleia da República (1995) approved "positive variable geometry" as one of the unanimous broad principles for the revision of the treaty (see also Macedo, 1995 and Magone, 1997). This principle matches the enhanced cooperation among independent central banks called for by the treaty. It originated in the negotiations for a single European currency and has been part of the unwritten code of conduct of the EMS since at least 1987. In light of the impending union deepening and widening, forms of flexible integration such as this one have become almost inevitable.

The analysis draws on Commission (1990), a report under the title One Market, One Money whose chapter 9 brings out how a government in the periphery of international currency standards may earn credibility by changing its economic regime in the direction of currency stability. Section 2 brings back the lessons from gold convertibility as a guarantor of stability, brought together in Macedo et al (1996) with an application to Portugal. These are relevant here: yesterday, like today, politics determines the interaction between the commercial interests of the middle classes and the diplomatic aspirations of the central banks, as discussed ibid. by Bordo and Schwartz (1996), De Cecco (1996), Eichengreen and Flandreau (1996), Macedo (1996a) and Milward (1996).

The politics of EMU taken up in Section 3 are the process of multilateral surveillance conducted by the Council of Economics and Finance Ministers (ECOFIN), and involving the European Commission and the European Central Bank. The budgetary procedures agreed upon by all members - not just the members of the Eurozone - should tame excessive budget deficits, especially if a positive interaction with national parliaments develops over time. This means of earning credibility abroad is of course related to the exchange rate regime described in Macedo et al (2001a) and mentioned at the outset in connection with the portability of the European institutional architecture.

Section 4 provides some comparisons with the other union states eligible to receive transfers from the cohesion fund: they show that Portugal has fared well during stages I and II of EMU (Silva 1995, Macedo 1996b and 2001a), but that Ireland has fared better, probably because it managed to earn credibility earlier. Section 5 is related to the political debate on the future of Europe. It explores the implications of positive variable geometry as yet another means of earning credibility both for current and prospective EU members.

Section 6 focuses on the time it takes to earn credibility and provides evidence on the differences in ratings between nations, regions and cities in the run-up to EMU. A number of concluding lessons about structural reforms remain relevant for the fiscal decentralisation prospects in both current and candidate member states, reinforcing the threat of the "Euro hold up" (Macedo 2001a, and references therein, notably Buiter and Sibert 1997). From Section 7, it is seen that this principle of flexibility applies to region and city governments. Obtaining international ratings for the debt of subnational governments as Azores did in 1996 can be seen in this light.

The gold standard evolved out of the bimetallic and silver standards of the earlier 19th century but only for a short period did it actually embrace the better part of the world. Price and exchange-rate stability, the most praiseworthy features of a specie standard, were largely limited to its North Atlantic core. Moreover, the design of international currency standards cannot afford to neglect domestic and international politics. Gold convertibility, for one, was associated with economic development and with the constitutional rule of the middle class.

The gradual displacement during the second half of the 19th century of alternative monetary arrangements reflected the growing political influence of the industrial and commercial classes rather than efficiency considerations alone. This was particularly evident in the debate which led Germany to join the gold standard in the 1870s.

Politics are again prominent in the behavior of central banks with respect to international capital flows. The success of an exchange rate policy, even under the gold standard, could hinge on the elusive factor of market confidence. The limitations of standard prescriptions of the steps the authorities should take to gain the market's respect must be underscored. The view that monetary authorities who are officially independent in fact enjoy freedom from political constraints is simplistic. Central bank policies under the gold standard were shaped from the start by the politics of banking and diplomacy.

For example, central banks held exchange reserves in foreign financial centers not just to finance intervention in the markets but also to further their nations' foreign policy goals. The same can be said of their relationship with the financial press - whose effects on the creditworthiness of individual sovereign borrowers often dominated other market perceptions. Examples of leaks to the financial press during the gold standard period show that the decision to join and the system’s operation were conditioned by political as well as economic factors, which also applied to the threat of inconvertibility. The subsequent development of rating agencies can be rooted in the need to provide more relevant information about credit risk.

In this context, exchange rate rules can play a useful role in buttressing the credibility of national macroeconomic policies. Comparative evidence supports the notion that, for a limited number of industrial countries, the gold standard and subsequent pegged-rate systems enhanced the credibility of policymakers' commitments to price stability. These rules were associated with price and exchange rate stability superior to that of alternative arrangements. Nevertheless, a contingent rule may be difficult in practice for investors to distinguish from purely discretionary policy.

The effects and effectiveness of an exchange rate rule depend on the economic and political context. In the contrasting experiences of different countries, the rule was respected only when specific domestic and international conditions were in place. Economic maturation and development cultivated support for the rule by creating a constituency of industrial and commercial interests who stood to benefit from monetary stability, and which increased the sectoral diversification of the economy, reducing its vulnerability to swings in primary commodity prices.

This constituency, in turn, helped monitor excessive budget deficits, insofar as they revealed governments' preference for inflationary finance. Because of the threat to credibility that gold inconvertibility represented, deficits were higher in periods of currency convertibility than when the currency had been forced off the international monetary standard.

Earning credibility involves medium term oriented budgetary policies which are not perceived as threats to price and exchange rate stability. Bartolini and Drazen (1994) show that this reflects the role of capital account convertibility as a signal of future policies.

National credibility is harder to achieve when the international standard is itself in turmoil. But currency crises make it very clear that credibility cannot be imported from abroad, it must be earned. Moreover, an exchange rate rule is not sufficient for credibility, although it can still enhance a domestic commitment to stable policies. Stability too must be achieved at home and it may take longer to be understood by the industrial and commercial interests if it is imported through an exchange rate peg.

The European Union has gone the furthest toward the removal of restrictions on currency convertibility as part of the single market in financial services and the three-stage move to a single currency established in 1993. Most member states seek to peg their currencies to one another within multilateral bands without the insulation offered by exchange restrictions. For such reasons, historical experience with convertible currencies and pegged exchange rates has particular immediacy for Europe. Countries which remain outside the parity grid during part of the 1990s experienced it before either formally as Italy and Britain, or informally as Sweden and Finland. Both Italy and Finland were among the eleven founding members of the Eurozone. Among the twelve current members, only Greece (who removed capital controls in 1994, after the beginning of stage II of the monetary unification process) retained some kind of sliding peg before joining the EMS in 1998 and the Eurozone in 2001.

The combined effort of central banks and national treasuries is at the heart of the multilateral surveillance procedures the European Union has adopted so as to insure the convergence of national economies toward price stability and sound public finances. The roots of these procedures go back to the co-operation of central banks during the gold standard and to global efforts at rescuing some exchange rate stability in the early 1970s, after the demise of the dollar standard.

In spite of the widening of fluctuation bands from 2.25% to 15% in August 1993, the creation of the European Monetary Institute on January 1, 1994 helped cooperation among central banks to become more operational during stage II of EMU. The treaty also introduced an "Excessive Deficits Procedure" involving the European Commission to determine whether budget deficits and public debt levels were such that individual member states qualified for EMU.

The annual procedure of excessive deficits has been tied to the broad economic policy guidelines and has involved all union states. It was specially relevant for the deficit countries receiving transfers from the cohesion fund (Greece, Spain and Portugal) since these were conditional on compliance with the convergence criteria. Yet such procedure has encountered difficulties of implementation, and is not subject to parliamentary scrutiny.

Due to these difficulties as well as to the convergence performance during the first years of stage II, stage III only began in 1999. The recession which afflicted the European economies during stage I increased the difficulty of meeting the convergence criteria. So did the foreign exchange market turmoil that erupted in 1992, forcing the realignment of the Italian lira and the Spanish peseta and then the exit of the lira and the pound sterling from the EMS. Turbulence persisted until EMS fluctuation margins were drastically increased in August of 1993.

The 15 per cent band was not fully utilised, even though political instability in conjunction with high unemployment did cause the Spanish peseta to fall to the bottom of its wide band in the winter of 1993-94 and a fourth realignment to take place in March 1995, as described in Macedo et al., 1999; see also Commission 1997). For most countries, then, the system has successfully eliminated the problem of one-way bets without condemning them to significantly greater exchange rate instability.

However, the external discipline provided by the narrow-band system is now absent, and each central bank must decide unilaterally whether to intervene to hold its currency within the old fluctuation bands. This required a rigorous interpretation of the convergence criteria for stage III of EMU, as revealed by the "Growth and Stability Pact" approved in 1996, which tightened the rules contained in the excessive deficit procedure as described in Macedo (2001b). The institutional requirements for a successful convergence go beyond the governments of member states. They involve the parliament and the court of auditors, both at the national and at the union level - aside from the independence of the central bank in matters of monetary policy. They also involve subnational entities, without whose contribution national cohesion cannot be implemented in practice.

European construction will be sustained if policy rules exist to protect the interests of present and future taxpayers unionwide. But institutions oriented to the avoidance of excessive future taxation will not take hold unless current voters appreciate the unsustainability of current policies. The convergence criteria for stage III of EMU can be seen in this light. Without them, the economic regime remains fragile and subject to policy reversals.

Since taxing and spending powers, as well as the design of budgetary procedures, remain with member states, the principle of no bail-out by the Community or by each other is the basis for the excessive deficits procedure. The treaty recognises that the public sector annual budget helps markets, social partners and taxpayers see the size of the public sector relative to private initiative. The "budget illusion" by virtue of which spending and borrowing by the government tend to be higher than what would be socially desirable is lessened by this multilateral surveillance.

There are two reasons for the bias underlying this deficit illusion. Spending may be excessive because marginal cost of financing is not fully accounted for. Debt finance may be excessive because the interests of future tax-payers are under-represented. A high share of open-ended expenditures (transfers to households, interest payments on public debt and government wage bill) increases the bias. More generally, expenditures which create entitlements, make it difficult to sort out the effect of economic cycles and the effect of discretionary policy decisions.

Remedies to budget illusion include contingent reductions in expenditure and increases in revenue due to uncertainty in forecasting both sides of the budget. On the whole, appropriate budget procedures ensure that the authority representing the collective interest in the efficiency of public finance dominates over spending agencies, including those responsible for entitlements. Given the amounts involved, social security policies turn out to be decisive in the evaluation of future expenditures. The implications of the stability culture in the transition to EU membership are dealt with in Branson et al (1998).

On the eve of Portugal’s first presidency of the Council of the European Community, a convergence program was presented by the government who had won the October 6, 1991 elections, involving a multi-annual fiscal adjustment strategy and a pre-pegging exchange rate regime accompanied by capital account liberalization. Dismantling the controls on capital inflows - which had been tightened in 1990-91 in the name of monetary stability - turned out to be a major battle against traditional practices in banking supervision.

The reason for the resistance of the central bank bureaucracy was that both convertibility and stability had been forgotten since they had not been observed together for over 100 years. To the contrary, all banks had been nationalized without compensation in the aftermath of the 1974 Revolution and no private banks were allowed until 1985. In the interim period, central bank supervision acquired features normally found in Soviet style financial systems and forgot the experience of earlier times, when the central bank had private shareholders and the currency was stable, if not fully convertible.

No wonder then that, in spite of the convergence program, the decision to request entry of the escudo in the exchange rate mechanism of the EMS on 4 April, 1992 - the weekend following the approval in parliament of the 1992 budget - was a genuine surprise to most people. The social partners were briefed right after a special cabinet meeting proposed a rate of 180 escudos per ECU (now Euro). The monetary committee acting as a representative of the ECOFIN including Central Bank Governors, agreed on a slightly stronger parity than proposed because, on the eve of the British general election, a weaker escudo might be contagious to sterling.

Nearly ten years elapsed between the change in regime brought about by a bipartisan elimination of the constitutional ban on privatisations in 1989 and the selection for the Euro (Macedo et al 1999). In spite of the succession of two prime Ministers of two different parties, five Finance Ministers and three Central Bank Governors during that interval, international investors believed that economic policy in Portugal retained a medium term orientation. The upgrading of Portugal’s debt to a higher investment grade (AA-) by Standard & Poors and the return to external borrowing in 1993 began to reveal the benefits of the new regime in terms of declining currency risk premium. In spite of a substantial decline in domestic inflation, the Euro parity became 200 escudos - around 10% higher than requested initially.

But the medium term orientation was not immediately understood - let alone believed - by social partners, taxpayers and domestic citizens generally. Indeed, a broad domestic social and institutional - especially parliamentary - support for a medium term stance of economic policy only appeared after Prime Minister Cavaco Silva declared he who not seek reelection on 1 October, 1995. His party was defeated but the combination of financial and political stability endured under Prime Minister Guterres and with it the credibility earned since the change in regime. Unfortunately, shortly after being selected for the Euro, Portugal´s European policy took a turn for the worse and the success of the second Presidency of the EU Council was not enough to offset this. Policies since the elections of October 1999 have been criticised by international investors as erratic and the succession of three Finance Ministers and two Central Bank Governors in the last two years has contributed to the change in perception.

Convergence indicators in each one of the 4 cohesion states relative to the 15 member union average are reported in Macedo (1996a). They show the effect of the timing of the regime change (Ireland, 1987; Spain, 1989; Portugal, 1992; Greece, 1998). Aside from unemployment, which is lowest in Portugal, long term interest rates are forecast to be below those of Spain while they were highest during stage I. Portugal and Spain report budget deficits which are half of Greece's but more than twice that of Ireland. Portugal and Greece improve from stage I to stage II. Note that, because of Portugal's lower level of public debt, its interest burden is no higher than Ireland's. All four states have excessive public debts, stemming from unsustainable past policies.

Turning to the external accounts, an excessive current account deficit may bring pressure to the foreign exchange market, particularly if it is perceived as unsustainable. The negative signal to the medium term policy credibility of the state will be especially strong if the public sector is spending too high a share of domestic resources. Two cases illustrating the polar extremes during stage II were Ireland, with large and consistent public and external surpluses, and Greece, with substantial public and external deficits. Portugal and, to a lesser extent, Spain displayed moderate external deficits for 1994-96 in spite of public deficits which are twice as large as required in the treaty. This suggested that some credibility had indeed been earned, making the future reduction in these deficits likely.

In spite of this performance during stage II, Portugal did not manage to sustain convergence after 1999 and became a possible victim of the "Euro hold up" mentioned above. It certainly has a long way to go before it reaches the standard of living of Ireland or Spain, whilst Greece has been converging again since its belated regime change.

In the international monetary system of the second half of the 19th century, there existed several currency blocs, each with a centre and a periphery, rather than a unified world system with a single core. Monetary arrangements in each bloc depended not just on factors common to countries at comparable stages of economic development but on the particular history and economic characteristics of the countries comprising the bloc.

There is an obvious analogy between this geography of the gold standard and the European debate over the feasibility and desirability of institutional arrangements with variable geometry. As discussed in Macedo (2001b), these have been observed in the Nice treaty, both about economic and monetary union and about the social charter and also in the Schengen agreement dealing with the free movement of people. In other words, it may be similarly useful to distinguish several groups of countries within the emerging European economy.

Multilateral cooperation procedures with the associated states of Central and Eastern Europe have thus been introduced to prepare accession negotiations - always a bilateral process between the applicant and the union. These procedures show that including all member states willing and able to participate in particular policies - can have a positive effect on the need to combine union deepening and widening.

The reason lies in the method of European construction: fostering international interdependence by cooperation among all levels of government, instead of defensive measures involving some form of protection against foreign competition. This multilateral surveillance is based on peer pressure as well as on the threat of sanctions. It certainly needs further improvement in the economic and monetary areas. Nevertheless, a medium term strategy was contained in European Community (1993). Moreover the annual economic policy guidelines issued since then have proven a useful monitoring instrument.

The economic policy dialogue within the union may bring about the kind of social consensus that is required to overcome diverging interests and establish national cohesion during the transition to EMU. As it extends beyond the union, it may help create the relevant political and market institutions. These would reflect the values of good government underlying European construction which Cahiers (1995) - taking inspiration in the work of the Portuguese parliament mentioned at the outset - lists as proximity to the citizen, national legitimacy and democratic accountability, P,L, A for short.

The simultaneous widening and deepening of the union implies a permanent negotiation among nation states, based on enduring agreements set up by the main political parties. From this point of view, the institutional balance among Community institutions cannot support a closed core of decision-making bodies. Nevertheless member states cannot block the need for union deepening expressed by a majority of them. This majority, in turn, must respect the impossibility for some member states to participate immediately in the deepening process wanted in some areas, because they do not meet the required conditions.

The notion called positive variable geometry by Assembleia da República (1995) is not the only form of flexible integration, but it is the most favorable. Since it is based on non-exclusion, it differs from a closed list of core countries. Since an unanimous vote of all union states is necessary to define criteria for entry as well as opt-out clauses for any subset thereof, it also differs from "à la carte" schemes. Positive variable geometry became a more prominent feature of the union after the revision of the treaty in Amsterdam and Nice (CEPR 1996 and 2001 and Macedo et al 2001a).

Enhancing price and exchange rate stability and buttressing the soundness of public finances is a formidable task outside the stable core of the international currency standard. In countries with histories of high inflation, neither the social partners nor public employees automatically appreciate the benefits of the regime change that the policymakers are attempting to engineer.

Because information about the change in regime is not readily available to international financial markets, errors in policy appraisal can unduly raise the costs of reform. Repeated market tests of the authorities' commitment to exchange rate stability may result. If these tests of the authorities' resolve greatly increase the cost of defending the exchange rate, they can lead to policy reversals.

This is one reason why the treaty instructs the European Council to issue broad guidelines against which policy and performance in the member states are to be gauged. With such guidelines at hand since the meeting in Brussels shortly before the beginning of stage II of EMU, the markets have been better able to appraise the progress of policy reform.

How long will it take for the public and the markets to recognise that the policy regime has changed? How quickly can national credibility be earned? While in a certain sense credibility can never be taken for granted, some time is needed for a nation to acquire a reputation for financial probity.

The number of years most frequently cited in financial circles is 10. This typically involves several general elections where alternative views of society may confront each other. A decade suggests that it may be better to take time and set on foot a self-reinforcing process of reform than to attempt a succession of overly ambitious and excessively drastic measures that will ultimately fail, damaging credibility. Once a national process is under way, regions and cities benefit from the increase in the so-called "sovereign ceiling" but only to the extent that they also manage to apply the principles of good government mentioned earlier as P, L, A (Cahiers 1995 and Macedo 1995). In particular, subnational governments must not act as candidates for bail-out by the national budget. Again, an internationally rated issue of external debt may help provide the signal to markets and citizens.

Table 1 lists the 15 regions and cities rated as investment grade by the two main agencies in early 1996. The ratings in the second and third column can be compared to the sovereign ceiling in the fifth and sixth columns respectively. It is seen that Sweden and Italy have a split ratings between the two agencies, with Standard & Poor´s showing a rating respectively two and one notches below Moody's. In addition, Catalunya, Madrid and Barcelona in Spain and Seine et Marne in France also have split ratings. The last column shows the combined effect of the split rating and of the difference relative to the sovereign ceiling. In the four cases just mentioned there is a one notch difference. This contrasts with the case of the German lander, and the other Spanish and French regions where there is no difference. The most striking case, though, is that of Naples where there is a four notch difference because against Standard & Poor´s.

To construct a social consensus domestically, signals that the authorities are committed to reform must be credible. If stable democratic governments succeed in implementing such credible reforms, helping to achieve convergence between poorer and richer nations, regions and cities, they can set off a self-reinforcing virtuous cycle of stability and growth. If short-lived governments, fearing the social conflicts associated with reforms, delay implementation and impair convergence, on the other hand, there will be a vicious circle. The oral tradition of Southern European monetary history values the latter more than the former, sometimes because it has forgotten the virtuous cycles. In a comparative exercise, the example of Portugal stands out as a country where the stability culture has deeper roots than previously thought (Macedo et al 2001b).

The initial conditions a government inherits may limit the alternatives at its command. For example, the 1992-93 recession aggravated the plight of Europe's unemployed, making it more difficult to reduce the generosity of unemployment benefits. At the same time, by demonstrating the costs of labour market rigidities and the importance of competitiveness at the firm level, the experience of the 1992-93 recession may have actually encouraged structural adjustment and, ultimately, cohesion.

If reforms are enduring, employment-generating growth will be stronger. This will brighten the prospects for completing the transition to EMU, and the union's commitment to stable exchange rates will gain credibility. This terminal condition, and the currency stability it delivers, will then feed back to a more employment-friendly economic environment in a virtuous cycle.

Conversely, if terminal conditions lack credibility, this may produce a "stop-go" convergence process that hinders change. Temporary, unaccountable shifts in sentiment in financial markets thus may disrupt the convergence process permanently. A government can only protect itself from this threat by acquiring a reputation for subordinating other goals of economic policy to the pursuit of convergence.

Here again, multilateral surveillance can play a role in providing timely information on national economic policies in a way that enhances the reputations of deserving governments. The same is true of the adoption of appropriate budgetary procedures at national and union levels. This applies not only to nation states but also to regions and cities throughout the union.

Earning credibility improves convergence and cohesion. With adequate national, regional and global governance, there is no trade-off between political and financial stability, no fundamental conflict between citizens (including their multiple allegiances to city, region, nation and indeed union as argued in Macedo 1995) and international financial markets -. Adequate governance runs, it is true, counter to the usual assumption about monetary and exchange rate policy at the periphery of international systems. With that caveat in mind, the conclusions from the unusual alliance between citizens and markets that this process requires are four.

First, completing the convergence process requires reinforcing domestic political support for currency convertibility and stability - and for the policies its maintenance implies, such as sound public finances. It requires solidarity among the member states of the European Union and their continued dedication to policies of convergence. One might think that these domestic and international prerequisites for the maintenance of currency convertibility and stability in Europe are very different from those on which earlier experiments like the classical gold standard were based. In fact, these prerequisites have remained remarkably similar over time.

Second, enduring historic similarities in international currency standards come from their role as public goods for the associated nation states. Adequate provision of the public good of systemic stability rests on the actions of the largest national economy. Germany must provide not just the price stability demanded of the anchor country but a level of interest rates. The incentive to free ride in the provision of this public good rises as the number of union states increases because individual countries have less capacity to internalise the benefits of contributing the public good.

Third, the benefits of establishing currency convertibility and maintaining exchange rate stability, which also contribute to the stability of the convertible-currency system as a whole, are least apparent for small countries. From this follow the very different experiences of so-called core and peripheral countries that have long characterised the history of the international monetary system and that earning credibility through positive variable geometry can mitigate.

Fourth, stability and convergence in Europe and a successful transition to monetary union require dedication on the part of the union, to providing the public good of monetary stability by maintaining low inflation and a level of interest rates conducive to growth and adjustment throughout the European Union. To spread the burden of convergence, each member state must follow stability-oriented medium term macroeconomic policies, monitored by the ECOFIN, together with the European Commission, the European Central Bank and national parliaments.

The European example of positive variable geometry on the road to enlargement suggests that domestic political consolidation and multilateral surveillance procedures are both needed to sustain international cooperation among national and subnational governments. Both seek international ratings for their debt of subnational governments as a means of earning credibility faster and therefore increasing the benefits that nations, regions and cities can reap from EMU. As, together with central banks, national parliaments are typically involved in the process of authorizing external debt issues, this is another reason why they should also be more involved in European affairs.

Assembleia da República (1995), Resolução Nº 21/95, Diário da República, 8 April.

Bartolini, Leonardo and Alan Drazen (1995), Capital Account Liberalization as a Signal, American Economic Review

Bordo, Michael and Anna Schwartz (1996),"Fixed Exchange Rates as a Contingent Rule 1880-1990," in Macedo et al..

Branson, William, Jorge Braga de Macedo and Jurgen von Hagen (1998), Macroeconomic Policy and Institutions in the transition to European Union membership, NBER Working Paper.

Buiter, Willem and Anne Sibert (1997), Transition Issues for the European Monetary Union, unpublished paper, September

Cahiers de la Fondation pour une Histoire de la Civilisation Européenne (1995) nº 1, p. 164 ff

Center for Economic Policy Research (1996), Flexible Integration: Towards a more effective and democratic Europe, London: Monitoring European Integration 6.

Center for Economic Policy Research (2001), Nice Try: Should the Nice Treaty be ratified?, London: Monitoring European Integration 11.

Commission of the European Communities (1990), Report One Market One Money, European Economy, Brussels, October

Commission of the European Communities (1997), The Economic and Financial Situation in Portugal in the Transition to EMU, European Economy special reports

De Cecco, Marcello (1996), "Short-Term Capital Movements," in Macedo et al..

Eichengreen, Barry and Marc Flandreau (1996), "The Geography of the Gold Standard," in Macedo et al..

European Community (1994), White Paper on Growth, Competitiveness and Employment, Brussels.

Macedo, Jorge Braga de (1995) Multiple allegiances as fate: the Portuguese idea of Europe, paper presented at a conference promoted by the Luso-American Development Foundation, Lisbon, November.

Macedo, Jorge Braga de (1996a), "Converging towards an European currency standard: Convertibility and Stability in the 1990s and Beyond " in Macedo et al..

Macedo, Jorge Braga de (1996b), Portugal and European Monetary Union: Selling Stability at Home, Earning Credibility Abroad, in Monetary Reform in Europe, edited by Francisco Torres, Lisbon: Universidade Católica

Macedo, Jorge Braga de (2001a), Crises? What crises? Escudo from ECU to EMU in Short-Term Capital Flows and Economic Crises, edited by Stephany Griffith-Jones, Manuel Montes and Anwar Nasution, Oxford, Oxford University Press

Macedo, Jorge Braga de (2001b), The euro in international finance, Acta Oeconomica, forthcoming

Macedo, Jorge Braga de, Barry Eichengreen and Jaime Reis (1996), editors, Currency Convertibility: The Gold Standard and Beyond, London: Routledge.

Macedo, Jorge Braga de, Luís Catela Nunes and Francisco Covas (1999), Moving the escudo into the euro, CEPR Discussion Paper nº 2248 October 1999

Macedo, Jorge Braga de, Daniel Cohen and Helmut Reisen (2001a), Monetary Integration for Sustained Convergence: Earning Rather than Importing Credibility, Don´t fix don´t float, edited by Jorge Braga de Macedo, Daniel Cohen and Helmut Reisen, OECD Development Centre Study, September

Macedo, Jorge Braga de, Álvaro Ferreira da Silva and Rita Martins de Sousa (2001b), War, taxes and gold: the inheritance of the real, Transferring Wealth and Power from the Old to the New World, edited by Michael Bordo and Roberto Cortes-Conde, Cambridge: Cambridge University Press

Magone, José (1997), European Portugal: The difficult road to sustainable democracy, London: Macmillan.

Milward, Alan (1996), "The Origins of the Gold Standard," in Macedo et al..

Silva, Aníbal Cavaco (1995), As Reformas da Década, Lisboa: Bertrand.

Table 1 Rating of cities and regions relative to nations

(listed by alphabetical order of the sovereign)