The Governance of a Fragile Eurozone

When entering a monetary union, member countries change the nature of their sovereign debt in a fundamental way; that is, they cease to have control over the currency in which their debt is issued. As a result, financial markets can force these countries’ sovereigns into defaulting. This makes the monetary union fragile and vulnerable to changing market sentiments. It also makes it possible that self‐fulfilling multiple equilibria arise. I analyse the implications of this fragility for the governance of the Eurozone. I argue that the role of the European Central Bank as a lender of last resort is crucial in reducing the fragility of the Eurozone. In addition, steps towards a budgetary union are key in structurally strengthening the union.     

Monetary union or currency competition? Currency arrangements for monetary stability in East and West

Recent events in the European Monetary System on the one hand and monetary disintegration in the former Soviet Union on the other hand have revived interest in the question of how to design and choose a monetary regime for both parts of Europe that ensures monetary stability. The objective of monetary stability can be achieved either by complete monetary union or by currency competition. Building on Hayek's ideas, I argue that both regimes are viable solutions depending on the circumstances. The paper first focuses on the misperceived benefits of flexible exchange rates, making the case for monetary union in Western Europe. However, monetary union is no alternative for Eastern Europe and the former Soviet Union. Instead currency competition could be used to retain the benefits of flexible exchange rates and to foster monetary stability at the same time.     

Contagion across Eurozone’s sovereign spreads and the Core-Periphery divide

This paper investigates the causes of disproportionate increases of sovereign yields with respect to the interest rate on the 10 years German Bund within the Eurozone. Empirical evidence drawn from the Bank for International Settlements dataset on banks’ portfolios shows that rapid financial integration, following the launch of the monetary union, resulted in excess exposure of Core countries’ banks in the Peripheral countries’ financial assets. In order to endogenize the possibility of contagion effects, we conduct econometric estimates through a Global Vector Autoregressive model, where each country’s spread depends upon all Eurozone countries’ spreads. Results show that after the burst of the financial crisis the Core countries’ sovereign yields are essentially determined by the international risk aversion, whereas the spreads of Peripheral countries mainly depend on fundamentals, namely the public debt/GDP ratio and the Real Effective Exchange Rate values with respect to the Eurozone average. These results are supported by the estimate of an impulse response analysis. Macroeconomic failures in public finances and competitiveness seem to originate the exceptional increases in sovereign spreads of the Periphery, through a contagion effect which is limited to this group of Eurozone countries.     

The endogeneity of the Optimum Currency Area criteria in East Asia

The Asian financial crisis in mid-1997 has increased interest in policies to achieve greater regional exchange rate stability in East Asia. It has renewed calls for greater monetary and exchange rate cooperation. A country's suitability to join a monetary union depends, inter alia, on the trade intensity and the business cycle synchronization with other potential members of the monetary union. However, these two Optimum Currency Area criteria are endogenous. Theoretically, the effect of increased trade integration (after the elimination of exchange fluctuations among the countries in the region) on the business cycle synchronization is ambiguous. Reduction in trade barriers can potentially increase industrial specialization by country and therefore resulting in more asymmetry business cycles from industry-specific shocks. On the other hand, increased trade integration may result in more highly correlated business cycles due to common demand shocks or intra-industry trade. If the second hypothesis is empirically verified, policy makers have little to worry about the region being unsynchronized in their business cycles as the business cycles will become more synchronized after the monetary union is formed. This paper assesses the dynamic relationships between trade, finance, specialization and business cycle synchronization for East Asian economies using a Generalized Method of Moments (GMM) approach. The dynamic panel approach improves on previous efforts to examine the business cycle correlations — trade link using panel procedures, which control for the potential endogeneity of all explanatory variables. Based on the findings on how trade, finance and sectoral specialization have effects on the size of common shocks among countries, potential policies that can help East Asian countries move closer toward a regional currency arrangement can be suggested. The empirical results of this study suggest that there exists scope for East Asia to form a monetary union.     

Is East Asia an optimum currency area?

This paper assesses the empirical desirability of the East Asian economies to an alternative exchange rate arrangement (a monetary union) that can potentially enhance the exchange rate stability and credibility in the region. Specifically, the symmetry in macroeconomic disturbances of the East Asian economies is examined as satisfying one of the preconditions for forming an Optimum Currency Area (OCA). We extend the existing literature by improving the methodology of assessing the symmetry shocks in evaluating the suitability of a common currency area in the East Asian economies employing the Bayesian State-Space Based approach. We consider a model of an economy in which the output is influenced by global, regional and country-specific shocks. The importance of a common regional shock would provide a case for a regional common currency. This model allows us to examine regional and country-specific cycles simultaneously with the world business cycle. The importance of the shocks decomposition is that studying a subset of countries can lead one to believe that observed co-movement is particular to that subset of countries when it in fact is common to a much larger group of countries. In addition, the understanding of the sources of international economic fluctuations is important for making policy decisions. The falling share of country specific factor and the rising role of region factor indicate that East Asia has become increasingly favorable for a monetary union. However, the share of country-specific factor that is still significant implies that it could be costly to renounce individual currencies to advance into a monetary union in East Asia.     

现行国际货币体系的不公正性与发展中国家的策略

现行国际货币体系的基本特征是储备货币多元化和以浮动汇率制为主流的汇率制度选择自由化，发展中国家似乎摆脱了原有的布雷顿森林体系和纪律和约束。但实际上，在现行国际货币体系下，发展中国家在储备货币依赖、江率制度选择、国际收支调节和抑制国际投资本冲击等方面均受到不利的影响（甚至是伤害）。本文首先论述了现行国际货币体系对发展中国家不公正性的表现，然后深入分析了其根源，最后提出了发展中国家应采取的若干策略。     

Excess volatility of real exchange rates in the EMS: some evidence from structural VARs

This paper argues that the effectiveness of the exchange rate mechanism (ERM) of the European Monetary System (EMS) should be gauged by its impact on the monetary component of real exchange rate variability. Nominal and real shocks are separated using a bivariate structural VAR applied to real exchange rate data of the six original member countries participating in the ERM and a control group consisting of Britain and the United States. The findings suggest that monetary shocks have been an important source of real exchange rate variability and that the ERM has been successful in reducing the incidence of monetary shocks across its member countries prior to the EMS currency crises of 1992–93, while being less successful thereafter.     

Gold dinar for the Islamic countries?

The Malaysian state of Kelantan has made a historical launch of Gold Dinar and Silver Dirham on 12th August 2010. For the first time in almost 100 years since the fall of the Ottoman Caliphate, a Muslim government introduces Shariah currency. In the eyes of many Muslim scholars, the present interest-based fiat monetary system is flawed as it is incompatible with the objectives of the Islamic law or the Shariah. There have been calls for the resurgence of Islamic Gold Dinar (together with the silver dirham) as it is deemed to be the most appropriate medium of exchange to be used in the Islamic economies. Using data from 1970 to 2007, this paper assesses the empirical desirability of the Organization of Islamic Conferences (OIC) countries to an alternative monetary system (Islamic Gold Dinar) that can potentially enhance the exchange rate stability and credibility. The Structural Vector Autoregression (VAR) method is employed to assess the nature of macroeconomic disturbances among the OIC countries. Specifically, the symmetry in macroeconomic disturbances of the OIC economies is examined as satisfying one of the preconditions for forming an Optimum Currency Area (OCA). In addition, this paper also investigates the output and price responses of OIC countries of the underlying structural shocks used to shed light on the suitability of these countries to form a monetary union. The preliminary findings of this study suggest the lack of broad linkages within the entire OIC, although there exists scope among some smaller clusters for potential monetary integration based on the symmetry of their business cycles.     

Commitment and the adoption of a common currency*

In contrast to Mundell's inquiry on the optimality of currency areas, this article aims to understand under what circumstances a Pareto‐dominant monetary union will be established. Using a multicountry overlapping generations model, we highlight gains from monetary union arising from reduced transactions costs and lower inflation. Despite these gains, countries acting independently will impose barriers to exchange through local currency restrictions, thereby creating transactions costs and providing an incentive for inflation. Therefore, the gains from monetary union are most likely to be lost without collective effort.     

The Attractiveness of the EMU Exchange Rate Stabilization Program

One of the arguments for a monetary union is that it reduces the variability of exchange rates. This paper demonstrates that the welfare gain that EU countries can expect to gain from the move to a single currency is moderate. The gains from exchange rate stabilization are limited by imports of foreign consumption goods and borrowing by governments. Furthermore, exchange rate stabilization may imply a welfare loss as the removal of non-zero exchange rate expectations deprives investors of the opportunity to speculate on expected-rate-of-return differentials. Numerical simulations suggest that the welfare gain from exchange rate stabilization for the average EU country is equivalent to a 0.9 percent rate of return on portfolio wealth.     

Lessons from the SUCRE and TARGET2 systems for a sound international monetary system in a financialized economy

More than 70 years after the Keynes Plan was originally created, it is still considered an alternative to the current International Monetary System (IMS) and many believe it contains potential benefits for issues such as global stability, employment and fair relations among countries. In fact, it has served as an inspiration for real cases of regional payment systems. In this article, the Keynes Plan is considered the main guideline for a specific reform proposal of the IMS in the twenty-first century. Therefore, our first intention will be to explain the main political and technical advantages of the Keynes Plan, which will serve as a prerequisite to subsequently identify the conditions for its optimal performance in the financialized economy of the twenty-first century. For that purpose, we draw lessons from the dynamics observed in two different regional payment-systems: the SUCRE in Latin America and the TARGET2 in the Eurozone.     

Tax competition,tax coordination and tax harmonization: The effects of EMU

There is little doubt that the step towards a monetary union in Europe will increase both the distorionary effects of existing differences in national tax systems and the intensity of tax competition for internationally mobile commodity and factor tax bases. This paper discusses selected issues of commodity and capital tax coordination that are likely to be affected by monetary unification. Starting from the distortive present scheme of value-added taxation in Europe we first analyze the effects of a switch to a general origin-based VAT as a way to maintain national tax rate autonomy over this important tax base. While an origin-based VAT would neither distort trade flows — both within the EU and with third countries — nor investment decisions in the long-run, its short-run effects are likely to be severe in the absence of exchange rate flexibility. In the field of capital taxation the focus switches to the feasibility of regional harmonization measures when there is no cooperation with the rest of the world. We argue that in a monetary union the mobility costs of capital will be significantly lower within the EU as compared to outside investments. This provides an efficiency argument for minimum source taxes on both interest income and corporate profits even if cooperation with third countries is infeasible.     

欧债危机成因与前景的制度分析

希腊等欧元区国家的主权债务危机可以说是欧洲区域一体化建设中的独特现象,其折射的是欧元区所存在的一个结构性问题：奉行单一货币政策和各国分散的财政政策,集中暴露出了欧洲货币一体化与欧洲福利资本主义的不相容、以及统一货币运行所要求的财政紧缩与欧元成员国经济增长和福利制度之间的矛盾与冲突;欧元不会就此瓦解,但欧债问题的最终解决困难重重;欧元的未来取决于自由与市场的回归欧洲,取决于欧盟的制度完善与欧式福利资本主义改革的成功与否。     

The Euro at ten: achievements and challenges

In this paper we discuss the achievements and the challenges of the Eurozone. We first analyze the record with respect to inflation. Second, we discuss the degree of price transparency in the Eurozone. Next we analyze the extent to which monetary union has promoted faster economic growth. Fourth, we study the challenges that arise from the increasing divergencies of wages and prices within the Eurozone. We conclude with a discussion of the governance of the Eurozone and the political issues to which this leads.     

Currency Areas and International Monetary Reform at the Dawn of a New Century

The Asian crisis and the creation of the euro have jump-started once again discussion of exchange rate systems, currency areas, and international monetary reform. The role of power in the international monetary system is discussed and its relevance to analysis of the new euro area as an instigator of change in the power configuration of the system. The dollar, euro, and yen areas have achieved a high degree of price stability, but international efficiency is seriously undermined by exchange rate gyrations of these three currencies. The best path to international monetary reform leads through a new international currency called the INTOR based on a G-3 monetary union platform possibly linked to gold.     

Revisiting the European Monetary System Experience: Were Some Members More Equal than Others?

Difficulties in implementing effective liquidity support – to counter speculative attacks – may partly explain why regional exchange rate agreements crawl regional trade integration. Our novel analysis of the European Monetary System confirms that liquidity support was provided under the discretion of the anchor country (Germany), and was indeed asymmetric across member countries and/or periods. In particular, it was less forthcoming (i) to countries further away from Germany (less politically influential there), (ii) to larger countries (interfering more with the Bundesbank's monetary control) and (iii) during periods when German inflation accelerated (and the Bundesbank needed a firmer grip on liquidity).     

COSTS AND BENEFITS OF EXCHANGE RATE STABILITY: CANADA'S INTERWAR EXPERIENCE

In January 1929, the Canadian government suspended gold exports and implemented a floating exchange rate regime that endured until the onset of World War II. In sharp contrast to the experience of other countries that left the gold standard, Canada's deflation and declining economic activity continued until 1933. This paper examines why the Canadian government chose to follow a restrictive monetary policy and how that policy affected the Canadian exchange rate. We show that the chosen policy was rational—given the government's assumptions and objectives—and that it was consistent with fiscal policy. In so doing, we argue that the government's commitment to monetary stability was credible. We show that one can explain the Canadian exchange rate's behavior by a simple expectations-based model of exchange rate determination, given external events and the government's monetary policy.     

The Economic Case for Monetary Union in the European Union

Differential requirements for seigniorage provide a weak case for retaining monetary independence. As regards adjustment to asymmetric shocks, nominal exchange rate flexibility is at best a limited blessing and at worst a limited curse. Absence of significant fiscal redistribution mechanisms among EU members is not an obstacle to monetary union. Neither is limited international labour mobility. Convergence of real economic performance is irrelevant for monetary union. A common currency is the logical implication of unrestricted capital mobility. The Maastricht criteria need not hinder monetary union provided the political will exists to adopt a flexible interpretation of the fiscal criteria.     

European monetary union, adjustment, and exchange rate variability

This paper uses a three-country, three-good, factor-specific model of trade with wage rigidities to investigate how European Monetary Union is likely to affect exchange rate variability. Focusing on international macroeconomic adjustment under both exogenous and optimizing monetary policies, it shows that the relative variability (against external currencies) of the euro and a basket of predecessor currencies depends on the relative sizes and specialization patterns of countries and the relative importance of different shocks. Monetary union is likely to decrease (increase) aggregate European exchange rate variability for shocks to industries in which large (small) euro area countries specialize.     

External debt and real exchange rates’ adjustment in the euro area: new evidence from a nonlinear NATREX model

In this article, we revisit medium- to long-run real exchange rate determination within the euro area, focusing on the role of external debt. Accordingly, we rely on the NATural Real EXchange rate (NATREX) approach which provides an explicit framework of the external debt–real exchange rates nexus. In particular, given the indebtedness levels reached by the euro area economies, we investigate potential nonlinearity in real exchange rates dynamics, according to the level of the external debt. Our results evidence that during the monetary union, gross and net external debt positions of the euro area countries have exerted pressures on real exchange rate dynamics within the area. Moreover, we find that, beyond a threshold reached by the external debt, euro area countries are found to be in a vulnerable position, leading to an unavoidable adjustment process. Nevertheless, the adjustment process, while effective, is found to be low and occurs slowly.