MACROECONOMIC STABILIZATION POLICIES IN THE EMU: SPILLOVERS, ASYMMETRIES AND INSTITUTIONS

This paper studies the institutional design of the coordination of macroeconomic stabilization policies within a monetary union in the framework of linear quadratic differential games. A central role in the analysis plays the partitioned game approach of the endogenous coalition formation literature. The specific policy recommendations in the European Economic and Monetary Union (EMU) context depend on the particular characteristics of the shocks and the economic structure. In the case of a common shock, fiscal coordination or full policy coordination is desirable. When anti‐symmetric shocks are considered, fiscal coordination improves the performance but full policy coordination does not produce further gains in policymakers' welfare.     

The monetary transmission mechanism: evidence and implications for European Monetary Union

We provide some evidence consistent with a heterogeneous credit channel of monetary policy transmission in the European Union. Using the techniques of cointegration and Error Correction Models, we have shown that the external finance premium is one important leading indicator of real economic activity in Germany and Italy. No evidence is found for France and the UK. Therefore, a common monetary policy implemented by the European Central Bank might be transmitted in different ways across the member countries of the monetary union, thus exacerbating existing regional disparities among the member countries.     

EMU, MAASTRICHT, AND THE 1996 INTERGOVERNMENTAL CONFERENCE

This paper presents various economic approaches to achieving monetary union, particularly in the context of European Economic and Monetary Union (EMU) as envisaged in the 1991 Maastricht Treaty. It evaluates the implications of Maastricht, given the economic convergence criteria embodied in the Treaty, in terms of economic policy for individual Member States and for the European Union (EU) as a whole. The paper assesses the EU's options for amending the Maastricht Treaty at its scheduled inter-governmental conference (IGC).     

THE POLITICS OF MAASTRICHT

The Economic and Monetary Union (EMU) treaty signed at Maastricht does not guarantee the recreation of German-style economic policies and outcomes at the European Community (EC) level. Membership was not limited to countries that mimic the German commitment to price stability. National representatives may outvote inflation-averse EC central bankers in monetary policy decisions. The Council of Ministers has the power to set exchange rate policy vis-à-vis third currencies. The treaty does not provide binding constraints against fiscal profligacy in member states. The German government agreed to this suboptimal outcome because in the wake of the demise of the Soviet Union and German unification it had broader political interests in maintaining the pace of European integration at Maastricht. The Bundesbank's policy of high interest rates in 1992, however, has effectively guaranteed a two-speed monetary union, in which the first group of members will be limited to a narrow deutschemark zone. Given the waning enthusiasm for integration across the EC, the German government has no incentive to alter this outcome.     

Fiscal Transfers in a Monetary Union with Exit Option

It is widely debated whether a monetary union has to be accompanied by a fiscal transfer scheme to accommodate asymmetric shocks. We build a model of a monetary union with a central bank and two heterogeneous countries that are linked by a fiscal transfer scheme with repercussions on monetary policy. A central bank aiming at securing the existence of a monetary union in the presence of asymmetric shocks has to compensate single countries for the tax distortions arising from fiscal transfers. Monetary policy may become more expansionary or restrictive depending on asymmetries between member countries' inflation aversion and exit costs.     

TOWARD A REGIONAL EXCHANGE RATE REGIME IN EAST ASIA

Abstract.  Deepening market-driven economic integration in East Asia makes intraregional exchange rate across the region increasingly desirable and necessary. The paper suggests that East Asia's emerging economies begin to choose a currency basket as a monetary policy anchor to enable all East Asian currencies to collectively appreciate vis-à-vis the US dollar, while maintaining intraregional rate stability, in the event of surges of capital inflows or a rapid unwinding of global payments imbalances. Following this initial step, East Asia may agree on more rigid intraregional exchange rate stabilization schemes through, for example, an Asian Snake or an Asian Exchange Rate Mechanism.     

Simple tests of target zones: the Irish case

In a small open economy with fixed exchange rates, tandard theory suggests that domestic inflation and interest rates should equal those abroad. In a credible target zone, the same theories suggest that inflation and interest rates should be ‘close’. Here, we seek to make precise this idea of limits on inflation and interest rate differentials consistent with limits on exchange rate movements. We then examine the case of Ireland, which joined the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS) in 1979 attracted by the prospects of lower, German influenced, inflation and interest rates. We find in the early years of the ERM, both Irish inflation and interest rastes were inconsistent with credibility of the exchange rate regime; in he latter years, from 1987 on, rates were in the derived range around German rates.     

Sharing Money Creation in a Monetary Union*

How to share money creation among the members of the European Monetary Union? To address this issue, we construct a two‐country New Open‐economy Macroeconomics model of an asymmetric monetary union with an incomplete financial market and home bias in consumption. We consider two sharing rules consistent with the current regulations of the European System of Central Banks. First, each participating National Central Bank supplies half of the European Central Bank determined money creation in the monetary union. Secondly, each National Central Bank adapts the national increase in money demand, under the constraint that the total money creation in the union does not exceed the level determined by the ECB for the whole union. We show that the current sharing rule, which ignores countries’ heterogeneity, is superior in terms of welfare. The key role of the current account is emphasized. It proves an efficient decentralized mechanism for allocation of money.     

Estimating the effect of the EMU on current account balances: A synthetic control approach

The European sovereign debt crisis wrought major political and economic damage on the European Monetary Union (EMU). This led to a reassessment of the pre-crisis period of economic growth and stability in the EMU, shifting attention to the macroeconomic imbalances that emerged between member states, especially those in current account balances. This paper uses macroeconomic data on OECD economies and a new statistical approach for causal inference in observational studies—the synthetic control method—to estimate the effect of the EMU on the current account balances of individual member states. This ‘counterfactuals’ approach provides strong evidence that the introduction of the EMU was responsible for the divergence in current account balances among member states in the run-up to the euro crisis. The results suggest that the EMU effect operated through multiple channels and that fundamental changes to the institutional framework of the EMU may be required to safeguard the currency union against a reemergence of dangerous external imbalances in the future.     

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.     

HETEROGENEITY IN A CURRENCY UNION WITH SOCIAL MARKET OBJECTIVES

In this paper, we explore whether heterogeneity among union members could threaten the stability of the European Monetary Union. The types of heterogeneity we consider are (1) asymmetries in the transmission of monetary and fiscal policies, and (2) differences in national preferences for price stability, output growth, and income redistribution. Our results show that the costs of membership can be significant for countries whose transmissions, structure, or preferences deviate from those underlying the common monetary policy. In part, these costs arise because monetary policy imposed by an independent central bank automatically constrains the use of fiscal policy by national governments.     

An Analysis of the Stability and Growth Pact

We use a stylised model to analyse the Stability and Growth Pact for countries that have formed the European Monetary Union (EMU). In our model, shortsighted governments fail to internalise the consequences of their debt policies for the common inflation rate fully. Therefore, while governments have no incentive to sign a stability pact in the absence of a monetary union, they do so with monetary union to restrain this externality. With uncertainty, a monetary union combined with an appropriately designed pact will be strictly preferred to autonomy. With differences in initial conditions, conflicts of interest arise. We study the Nash bargaining solution.     

Regimen changes and duration in the European Monetary System

This article examines the regime changes in the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS), applying the duration model approach to weekly data of eight currencies participating in the ERM, covering the complete EMS history. When using the non-parametric (univariate) analysis, it was found that for those regimens with long durations, the ERM would have been relatively stable, while for the (more common) regimes associated with short durations would have been more unstable. The probability of maintaining a certain regime is estimated to be 0.685. When applying a parametric (multivariate) analysis to investigate the role of other variables in the probability of a regime change, it is concluded that the interest rate differential with Germany and the magnitude of the realignment would have negatively affected the duration of a given regime, while credibility would have positively influenced such duration. Finally, when distinguishing between groups of currencies, it is observed that those in the core are more stable than those in the periphery, obtaining evidence against equality of survival functions among these groups of currencies.     

The Stability of Monetary Unions: Lessons from the Breakup of Czechoslovakia

In 1993, Czechoslovakia experienced a two-step breakup. On January 1, the country disintegrated as a political union, while preserving an economic and monetary union. Then, the Czech–Slovak monetary union collapsed on February 8. This paper analyzes the economic background of the two breakups from the perspective of the optimum currency area literature. The main finding is that the Czech and Slovak economies were vulnerable to asymmetric economic shocks, such as those induced by the economic transition. In particular, the stability of Czechoslovakia was undermined by the low correlation of permanent output shocks, low labor mobility, and higher concentration of heavy and military industries in Slovakia. J. Comp. Econom., December 1999, 27(4), pp. 753–781. Center for European Integration Studies (ZEI), University of Bonn, Walter-Flex-Strasse 3, 53113 Bonn, Germany, and Center for Economic Research, Tilburg University, Netherlands; Academia Istropolitana Nova, Bratislava, Slovakia, Central European University, Nador u. 9, 1051 Budapest, Hungary, and Center for European Integration Studies (ZEI), University of Bonn, Bonn, Germany; Institute for Advanced Studies (IHS), Stumpergasse 56, 1060 Vienna, Austria.     

Inflation analysis in the Central American Monetary Council

Though not working toward an imminent transition to a monetary or currency union, the Central American Monetary Council (or CMCA, from Spanish Consejo Monetario Centroamericano) serves as an institution promoting economic and financial stability among five Central American countries (Costa Rica, El Salvador, Guatemala, Honduras and Nicaragua) and the Dominican Republic. Econometric studies conducted by researchers from CMCA have mostly focused on studying inflation levels of these countries, making use of econometric tools such as VECM and cointegration. We expand the study of inflation stability in the member countries of the CMCA by adopting a long memory and fractionally integrated approach and implementing cointegration methods that have not yet been used in the study of the Central American Monetary Council. Our results first show that all the series of prices are nonstationary, with orders of integration equal to or higher than 1 in all cases. Looking at long-run equilibrium relationships among the countries, we only found strong evidence of a cointegration relationship in the case of Honduras with El Salvador. All the other vis-a-vis relationships seem to diverge in the long run. Policy implications of the results obtained are also derived in the paper.     

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.     

Economic and Monetary Union – Current Fiscal Disturbances and the Future

At the moment of its setting up the Economic and Monetary Union did not meet the criteria of the optimum currency area. Neither does it today. The crisis of public finance in the eurozone results from the abandonment public finance reforms, lack of consistency in enforcing the decision of the Stability and Growth Pact and, additionally, economic recession and financial crisis. Further functioning of the eurozone will depend on radical reforms of public finance and structural reforms enhancing efficiency of the market as an adjustment mechanism, and competitiveness of economies. The very establishment of the European Stabilization Mechanism and European Financial Stability cannot make up for the above mentioned necessary undertakings. It is important to change the socioeconomic model existing in the EU member countries.     

Leader of the pack? German monetary dominance in Europe prior to EMU

In this paper, the monetary policy independence of European nations in the years before European Economic and Monetary Union (EMU) is investigated using cointegration techniques. Daily data is used to assess pairwise relationships between individual EMU nations and ‘lead’ nation Germany, to assess the hypothesis that Germany was the dominant European nation prior to EMU. By and large our econometric investigations support this hypothesis, and lead us to conclude that the only European nation to lose monetary policy independence in the light of monetary union was Germany. Our results have important policy implications. Given that the loss of monetary policy independence is generally viewed as the main cost of monetary unification, our findings suggest a reconsideration of the costs and benefits of monetary integration. A country can only lose what it has, and in Europe the countries that joined EMU — spare Germany — apparently did not have much to lose, at least not in terms of monetary independence. Instead, they actually gained monetary policy influence by getting a seat in the ECB's governing council which is responsible for setting interest policy in the euro area.     

OUTLOOK FOR THE EUROPEAN MONETARY UNION: THE MESSAGE FROM EASTERN EUROPE

The European Community (EC) seems headed toward monetary union, either with "permanently" fixed exchange rates or with a common currency. Ceteris paribus, the breakup of the Soviet empire in Eastern Europe makes monetary union less desirable. One can expect further shocks from the East. Analyzing stock markets' reactions to events in the East from late 1988 to early 1990 shows that these shocks typically differentially affect EC members, particularly Germany. These differential shocks often call for adjustments in relative national price levels, which can be accomplished most easily with exchange-rate adjustments. The likelihood of such pressures reduces the credibility of a system of pegged rates and makes the system more vulnerable to speculative runs. A common currency is more credible by its nature but may give an inflationary bias to the European Monetary Union.     

Heterogeneous Mortgage Markets: Implications for Business Cycles and Welfare in the EMU

This paper evaluates business cycle effects of asymmetric cross‐country mortgage market developments in a monetary union. By employing a two‐country New Keynesian DSGE model with collateral constraints tied to housing values, we show that a change in institutional characteristics of mortgage markets, such as the loan‐to‐value (LTV) ratio, is an important driver of asymmetric developments in housing markets and economic activity. Our analysis suggests that the home country where credit standards are lax booms, while the rest of European Monetary Union faces a negative output gap. Overall welfare is lower if LTV ratios are higher.