Monetary Union and the Interest-Exchange Rate Trade-off

By using a multi-country simulation model this paper analyzes the qualitative effects of joining a monetary union. The transition to EMU (European Monetary Union) is shown to produce interest and exchange rate changes with substantial and countervailing effects on the real economy which can be traced through the model. Observable anticipation effects in the wake of the EMU are substantiated; and some policy recommendations for joining any monetary union are derived. It is also shown that fixing conversion rates at last-day market rates produces a unique outcome and not exchange rate indeterminacy as argued by De Grauwe (1997), Obstfeld (1998), and others.     

The European monetary system: Crisis and future

This paper examines the immediate and the fundamental causes of the crsis that hit the European Monetary System in September 1992 and August 1993 and the obstacles that European countries face in trying to achieve their ultimate goal of full monetary union, including a single currency and a union-wide central bank by the end of this decade. The conclusion that follows from the paper is that achieving full monetary union in Europe by the end of this decade is certainly possible but not certain. A major recession or other shock affecting asymmetrically more than one large member nation could derail or at least delay the process of monetary union. Although major benefits are expected to flow from monetary union in Europe, even more important are the political benefits that such a union would provide to its members.     

Lessons from historical monetary unions - is the European monetary union making the same mistakes?

This article examines three historical monetary unions: the Latin Monetary Union (LMU), the Scandinavian Monetary Union (SMU), and the Austro-Hungarian Monetary Union (AHMU) in an attempt to derive possible lessons for the European Monetary Union (EMU). The term ‘monetary union’ can be defined either narrowly or broadly depending on how closely it conforms to Mundell’s notion of ‘Optimal Currency Area’. After examining each of the historical monetary unions from this perspective, the article concludes that none of them ever truly conformed to Mundell’s concept, nor does the EMU. Nevertheless, the article argues that some lessons may be learned from these historical experiences. First, it is necessary that there exist robust institutions such as a common central bank and a unified fiscal policy in order to withstand external shocks. The three early unions could not withstand the shock of WWI. Another important lesson is that continuing national rivalries can undermine any monetary union.     

The International Reserves Issue in the EMU

This paper examines the effects of the Economic and Monetary Union on demand for foreign reserves. The traditional theory on demand for international reserves assigns a pivotal role to imports. However, in a currency union part of imports are settled in the common currency, leaving no incentive for keeping foreign reserves. Moreover, the pooling of the demand for reserves in the currency union and an increasing role of a currency as an international reserve currency may also influence, among other things, the union demand for reserves. Based on estimated demand functions for reserves it is shown that the Economic and Monetary Union has reduced the demand for reserves substantially. It is argued that an enlargement with new member countries of the European Union will result in further savings of reserves. A simple calculation at the end of the paper illustrates the welfare gain associated with the reduced need of reserves in the Economic and Monetary Union.     

Monetary Unions in Historical Perspective: What Future for the Euro in the International Financial System

This paper discusses the introduction of the euro in the present international monetary context. European Monetary Union is not only an economic concept but also primarily a political one. Based on past experience, two aspects of monetary union seem essential: the nature of the future European Central Bank and the necessity that monetary union is implemented with a fiscal union. The euro's success on world markets, as a dollar substitute, depends on monetary authorities' credibility in targeting low-inflation, and on fiscal authorities' reputation. A central bank that does not respond to a political authority can cause social difficulties, especially if social policies are left in the hands of single countries and fiscal transfers, to support these policies, are not allowed     

Measuring Monetary Conditions in Europe: Use and Limitations of the MCI

The Monetary Conditions Index is a composite index of interest and exchange rates frequently used by (central) banks, the IMF, and the OECD. This paper considers the benefits and weaknesses of the MCI in the light of large macroeconometric models. It follows that the impact of the exchange rate on GDP relative to the impact of the short-term interest rate is substantially lower under a monetary union. For most countries, including a long-term interest rate in the MCI only affects the level of the MCI and not its turning points.     

Regional currency arrangements: insights from Europe

This paper focuses on the requirements and features of a successful monetary union on the basis of the optimum currency area theory, the “logical roadmap” for integration as proposed by Balassa as well as the economic and institutional framework of the European Economic and Monetary Union (EMU). The analysis suggests that monetary union is contingent upon high economic integration and strong political commitment. However, political union is not an ex-ante requirement. Outside factors such as systemic shocks and globalization seem to speed up the pooling of sovereignty in the economic domain. A firm commitment to stability-oriented monetary and fiscal policies is a precondition for gaining credibility and trust within and outside a monetary union. Last, but not least, convergence criteria, fiscal rules and strong institutions are necessary to help ensure and monitor the participants’ compliance. However, the European experience is not a blueprint for regional integration that can be directly and entirely applied to other regions.     

Rotating Slumps in a Monetary Union

In the decade since its creation in 1999, the European Economic and Monetary Union (EMU) has experienced surprisingly large and persistent inflation differentials across member states causing substantial shifts in relative price levels. At the same time, member countries exhibited distinct non-synchronized output fluctuations, giving rise to a pattern of ‘rotating slumps’ (a term coined by Olivier Blanchard). This paper presents a stylized theoretical model of a monetary union which demonstrates how inflation differentials and relative output movements interact dynamically. A number of implications are derived from the model. In particular, national fiscal policies are shown to have an important role in containing internal macroeconomic disparities in a monetary union. An optimal fiscal policy rule is derived from the model for that purpose.     

Monetary policy interaction within or without an exchange-rate arrangement

In a simple stochastic two-country model in which each country uses monetary policy to offset shocks that impinge on its national income, the policy rule chosen by each country is affected by the rule chosen by the other. A monetary union emerges as a Nash equilibrium (and is Pareto optimal) if the variance of shocks affecting the real exchange rate is small. An exchange-rate arrangement, and in particular a system of exchange-rate bands such as the European Monetary System (EMS), may create a need for more policy cooperation and may give scope for strategic asymmetries.     

国家自主性、中央银行独立性与国际货币合作——德国国际货币政策选择的政治逻辑

政治经济学文献表明,通过将货币政策交给具有独立性的中央银行来管理,政府可以增强货币政策承诺的可信性。但是,具有独立性的中央银行在政治过程中也构成了一个否决行为体,从而有可能限制国家(政府)的自主性。根据"结构导致的均衡"的分析视角,如果国家偏好与中央银行偏好不一致,何者可以转化为权威性行为将取决于该国的政治制度。在国内政治制度的变革难以实现的情况下,国家可以通过参与国际制度与国际谈判来改变中央银行与政府之间的既有均衡,并使这种均衡朝着增强国家自主性的方向演变。作为世界上独立程度最高的中央银行之一,德国联邦银行担心欧洲货币合作会干扰其维护国内币值稳定的目标,更不愿通过放弃本国货币马克来推进货币一体化。但是,德国联邦政府通过其在国际制度与国际谈判中享有的信息优势与合法性,克服了德国联邦银行对欧洲货币合作的反对,推动建立了欧洲货币体系和欧洲货币联盟。     

The future role of national central banks in the Eurosystem

This contribution describes some changes in European central banks after the start of the European monetary union. It explains how staffs at the national central banks cooperate with the staff at the European Central Bank. Furthermore, a few issues are discussed which relate to the organization of banking supervision in Europe. This paper represents the author's opinions and does not necessarily reflect the views of the Deutsche Bundesbank.     

Beyond Borders: The Euro Crisis and Public Support for Monetary Integration in East Africa

We show that economic experiences in one part of the world affect proposed policies elsewhere. Specifically, we find that the recent crisis in the European Monetary Union (EMU) has impacted negatively the public support for the new proposed monetary union in the East African Community (EAC), with a more pronounced effect for less educated Kenyans. That external effect is robust to controlling for an array of other factors such as the expected economic benefits from the union, the desire to gain international influence as part of a larger community and the memory of an earlier failed EAC monetary union.     

Fiscal policy independence in a European Monetary Union

Do plans for a monetary union in Europe call for limits on the freedom of the country members of the union to use fiscal policy? In order to provide a tentative answer, we simulate the IMF model MULTIMOD, given various shocks, in the case of a European Monetary Union consisting only of France and Germany. The results clearly indicate the possible value of allowing unfettered use of fiscal policy in both countries. The reasons lie partly in differences in the initial position of the two, partly in differences in their preferences. We also examine the change in the policy significance of the current account in the monetary union. Current account imbalances clearly cease to have the same significance in a monetary union; but they do not therefore become irrelevant.     

The European exchange rate mechanism and the European monetary union

Summary This article addresses two central questions related to the prospects of the Economic and Monetary Union (EMU) in Europe: first, is the current exchange rate mechanism viable in the transition stage to EMU or in the period to come if the EMU should be postponed? Second, is a monetary union necessary in an economically fully integrated European Union or would the current or an alternative exchange rate mechanism suffice an integrating Europe? The article reviews the arguments for and against monetary union, the history of European monetary integration, the theoretical and empirical insights into the functioning of targets zones, and the likely developments and prospects for the EMU.The author wishes to thank Martin M.G. Fase and Simon K. Kuipers for their most helpful comments on a previous version of this article.     

Fiscal and monetary policy in a monetary union: Credible inflation targets or monetized debt?

Fiscal and Monetary Policy in a Monetary Union: Credible Inflation Targets or Monetized Debt? —The paper examines the interrelationship between fiscal and monetary policy in a two-country monetary union. The worst scenario occurs when an independent central bank sets the nominal interest rate and responds to rising government debt/GDP ratios by monetization. The result is high inflation, high debt/GDP ratios and a large public sector. Government debt and inflation are contained if the governments bear sole responsibility for solvency, but the public sector remains excessively large. The best scenario occurs if the central bank removes the incentive for the governments to engineer surprise inflation by credible inflation targeting.     

International banking and transmission of the 1931 financial crisis

In May to July 1931, a series of financial panics shook central Europe before spreading to the rest of the world. This article explores the role of cross‐border banking linkages in propagating the central European crisis to Britain and the US. Using archival bank‐level data, the article documents US and British banks’ exposure to central European frozen credits in 1931. Central European lending was mostly done by large and diversified commercial banks in the US and by small and geographically specialized merchant banks/acceptance houses in Britain. Differences in the organization of international bank lending explain why the central European crisis disturbed few US banks but endangered many British financial institutions.     

Determinants of bond market development in Asia

One of the major reasons behind the Asian financial crisis in 1997 was the excessive dependence of the Asian economies on commercial banks for domestic financing. The region failed to diversify its sources of corporate financing as it relied mainly on banks since its other types of financing, namely bond markets, were still underdeveloped and their sizes were quite small. On the other hand, the 2008 global financial crisis and the ongoing European debt crisis have led to constraints in acquiring local currency and foreign currency liquidity in the corporate sector in Asia as foreign banks withdrew investments from Asia. Furthermore, Asia needs large long term capital (US$ 750 billion per year for 2010–2020) for developing infrastructure connectivity within and across its economies. Local and regional capital can be channeled for long-term infrastructure projects and other productive investment through bond markets. Having a well-developed local currency bond markets can enhance the resilience of domestic financial sector to external shocks and it can facilitate better intermediation of savings into productive investments in Asia. To enhance corporate bond financing, it is important to examine factors that affect the effective development of bond markets in Asia. The study attempts to identify the determinants of bond market development in Asian economies through examining the relationship of bond issuance with selected key financial and economic factors. It also intends to provide policy recommendations for the further development of the Asian bond market. Major determinants for bond market development in Asia include the size of an economy, the stage of economic development, the openness of an economy, the exchange rate variability, the size of the banking system, and interest rate variability.     

The stability of money demand in Germany and in the EMS: Impact of German unification

The Stability of Narrow Money Demand in Germany and Aggregate Money Demand in the EMS: Impact of German Unification. —This paper shows that the German monetary union not only had an impact on the stability of the narrow money demand in Germany but also on the stability of the aggregate demand for money in two larger European currency areas, consisting of three and seven EMS countries. However, the impact was only of a temporary nature. The empirical results show that the close link between real money, output, and the interest rate still exists. In a European Monetary Union, narrow money thus remains a potential candidate as an indicator and/or intermediate target for the European Central Bank.     

Reserve requirements,currency substitution,and seigniorage in the transition to European monetary union

This article considers a transition toward European monetary union that combines increased substitution of currencies and greater monetary, financial, and fiscal policy coordination. It explores how such a transition would affect national inflation and interest rates and required reserve ratios when governments depend in part on seigniorage funding for public expenditures. We find that greater coordination of policies would lead to lower inflation and interest rates but higher reserve-requirement ratios. Because higher reserve-requirement ratios could place European banks at a competititve disadvantage, we conclude that the interaction between reserve requirements and seigniorage concerns makes it less likely that the gradualist approach of the Maastricht treaty is a sustainable means of transition to European union.     

The current role of national central banks in the Eurosystem

This paper describes in some detail the tasks currently performed by the national central banks of the Eurosystem, using the Oesterreichische Nationalbank as an example. It does so against the background of the regime shift to the European economic and monetary union that occurred on January 1, 1999. It also sketches some of the issues which will need be addressed in the evolution of the division of labor between the European Central Bank and the national central banks.