Credibility of European economic convergence

Credibility of European Economic Convergence. — The authors analyze economic convergence and its relation to European real interest rate differentials using a clustering method on seven macroeconomic key variables for 1979–1995. The results indicate that monetary convergence has progressed considerably but that there is hardly any real convergence in the EU. They also perform pooled nominal and real interest rate regressions with the individual cluster indicators as explanatory variables. The authors find significant positive effects of external (current account) and internal (unemployment ratios, government finance) imbalances on real interest rates. They also group countries according to economic reputation and find that real indicators remain significant for the high-reputation countries.     

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.     

Fiscal flows in Europe: The redistributive effects of the EU budget

Fiscal Flows in Europe: The Redistributive Effects of the EU Budget. — In this paper we analyze the redistributive effects of the EU budget among European countries, exploring the relationship between income and fiscal flows, both in per capita terms. Using a new data set on EU budgets from 1986 to 1998, we find that the EU budget has a redistributive effect, though only on its expenditure side. The most redistributive expenditure category is the Regional Fund, followed by the Social Fund and by the guarantee section of the EAGGF. All of them have become increasingly redistributive in time. Total budgetary revenues show only proportionality with income. As regards the net financial balance, three groups of countries are identified, given the treatment they get from the EU budget that cannot be explained by their per capita income levels.     

What Should the Weights of the Three Major Currencies be in a Common Currency Basket in East Asia?*

We consider what type of regional common currency should be introduced in East Asia in the future. The common currency basket is, in itself, more desirable as an anchor currency. In this paper we define two types of currency basket and investigate the long‐term sustainability of adopting a common currency basket in East Asia. From our empirical results, a larger weight (but less than 100 percent) for the US dollar in the common currency basket tends to make bilateral exchange rates among East Asian countries stable in the long run.     

The linkage of interest rates within the EMS

The Linkage of Interest Rates within the EMS. — The paper explores the linkage between interest rates in Germany and the United States with those on other currencies within the Exchange Rate Mechanism (ERM) of the European Monetary System. Monthly data on money market interest rates and rolling window cointegration techniques are used. The principal findings are that during the early part of the sample period (1979–1995), there is widespread cointegration between both US and German interest rates and those on other currencies in the ERM; but during the later part of the sample, this “worldwide” linkage disintegrates, cointegration between German and other ERM interest rates strengthening whilst that with the US disappears.     

FINANCIAL AND MONETARY AUTONOMY AND INTERDEPENDENCE BETWEEN SOUTH AFRICA AND THE OTHER SACU COUNTRIES

The paper uses cointegration and error correction modelling techniques together with tests of weak exogeneity, and monthly interest rates for the period 1990 to 2005, to examine the degree of financial and monetary autonomy and interdependence between South Africa and the other Southern African Customs, Union (SACU) countries. The results reveal a high level of dependence of the other SACU countries' financial systems on South Africa's financial system, which suggests that a monetary unification with a single central bank (South African Reserve Bank) and monetary policy for the union is feasible.     

Horizontal and vertical intra-industry trade between Eastern Europe and the European union

Horizontal and Vertical Intra-Industry Trade Between Eastern Europe and the European Union. — The share of intra-industry trade (IIT) in total trade between central and east European nations and the EU is broken down into various components. Vertical IIT is found to account for 80 to 90 percent of total IIT. Controlling for country-specific effects, it is positively associated with product differentiation, labor intensity of production, economies of scale, and foreign direct investment (FDI). Horizontal IIT is also positively correlated with FDI and product differentiation; however, a significant negative relationship is found for scale and labor intensity.     

Comparing monetary policy transmission across European countries

Comparing Monetary Policy Transmission across European Countries. — This paper re-evaluates the estimation of monetary policy transmission. Within the Structural VAR framework, five methodological points are identified, recognition of which can help to improve the reliability and credibility of estimates. The findings of the methodological analysis are applied to the estimation of models for thirteen European countries. Results show that considerable differences in the transmission mechanism exist between these economies, mainly in intensity, but also in timing.     

Capital controls and international trade finance in a dual exchange rate regime: The Belgian experience post-mortem

Capital Controls and International Trade Finance in a Dual Exchange Rate Regime: The Belgian Experience Post-Mortem. — The purpose of the paper is to model “leads and lags” capital flows on the official segment of a dual exchange market and to examine the effects of various types of capital controls imposed by authorities on the official spot and forward exchange markets. The focus of the analysis is the degree of insulation provided by a “dual exchange market cum capital controls” in face of a speculative crisis. The crucial variables in this respect are the deviation from covered interest parity and the forward risk premium. Results of the theoretical model are confronted with empirical evidence over the 1975–85 period.     

Convergence - the Maastricht approach to economic and monetary union (EMU) in Europe

This article reviews the concept of convergence in the Maastricht Treaty and notes that, while in certain areas the convergence objectives are quite ambitious, in other areas the objectives for the transition period are surprisingly limited. By end-1992, much progress had already been achieved on convergence in a majority of EC countries (and countries applying for membership). Thus, despite the wave of pessimism that followed the recent exchange market crisis, it is still quite possible that a majority of EC members could qualify for monetary union by 1997. However, this would require further significant adjustment in many cases in the fiscal area. Based on the Multimod Model used at the Fund, the deflationary effect of this fiscal consolidation would be small and short lived.     

The monetary exchange rate model in the long run: An empirical investigation

The Monetary Exchange Rate Model in the Long Run: An Empirical Investigation. — This paper uses the Johansen multivariate cointegration method to examine three variants of the monetary approach to the long-run exchange rate model: flexible price, forward-looking and sticky price monetary models. Evidence is provided for four bilateral sterling exchange rates. The sensitivity of the results to the measurement of monetary aggregates is also examined. The cointegration results provide dismal evidence for the flexible price and forward-looking models irrespective of the measurement of money. The findings are more mixed for the sticky price model, particularly when broad money is used.     

The Dollar-Mark axis

The Dollar-Mark Axis. — Over the last two decades, most European currencies have tended to weaken against the mark as the latter strengthened against the dollar. Moreover, the strength of the response of European cross rates has tended to remain in the same order over time. The paper first sets out the stylised facts of this phenomenon, referred to as the dollar-mark axis, and then tries to identify its determinants. In addition to exchange rate policy, the paper examines the correlation of cyclical fluctuations and trade links and the bias of international investors in the currency composition of their portfolios.     

Breaking up a customs union: The case of the Austro-Hungarian Empire in 1919

Breaking Up a Customs Union: The Case of the Austro-Hungarian Empire in 1919. — This study has used new estimates of the gravity model to analyze the effects on European trade patterns in the mid-1920s of the break-up of the Austro-Hungarian Empire and its customs union after World War I. The gravity equation has been found to explain 70 percent of the variance of the trade flows of the principal trading nations in 1924–26. Moreover, the ties between the former members of the Austro-Hungarian Empire remained stronger than any other commercial relationship in Europe. They were second only in intensity — given economic and demographic factors — to those of the British Empire.     

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.     

The assessment: economics of transition in eastern and central Europe

This Assessment provides an overview of the stylized facts andthe underlying economic issues involved in transition, witha focus on the more successful reforming countries. Microeconomic,macroeconomic, and institutional factors interact. Particularemphasis is given to the initial output falls at the start ofreform, where it is suggested that a generalized price-raisingresponse by state enterprises to monetary tightness, liberalization,and devaluation was one of the main culprits. Trade liberalizationhas proved to be an extremely important and successful aspectof the strategies followed, but there are increasing dilemmasover exchange-rate policy at both the micro- and macroeconomiclevels. A partial solution is further progress with institutionaland, especially, banking-sector reform, but the policy conflictswill remain in an increasingly open and integrated internationalenvironment.     

The determinants of export performance: A firm-level study of Italian manufacturing

The Determinants of Export Performance: A Firm-Level Study of Italian Manufacturing. — This paper analyzes some determinants of a firm’s probability of exporting and export intensity and presents the findings of an empirical study carried out on a large sample of Italian firms. On the basis of Probit and Tobit estimates, it emerges that these determinants change according to the size of firms. In particular, only for small firms is the relationship between size and export performance positive. The export activity of small and medium-sized firms decreases with the share of sales due to subcontracting. Larger firms, instead, benefit more from being affiliated with business groups and performing innovative activities of a different nature.     

Fiscal policy in monetary unions: Implications for Europe

This paper analyzes how the feasible mix of government expenditure and financing arrangements may change with the establishment of a monetary union such as that planned by members of the European Community. We find that a monetary union reduces the feasible divergence across countries in their present discounted levels of fiscal spending. Wide differences across countries in their present and future time patterns of spending are still possible, however. Examination of the empirical evidence suggests that the movement toward greater exchange rate fixity associated with the EMS and participation in quasi monetary unions havenot been accompanied by significant fiscal convergence. The experience of member states of several existing monetary unions, however, suggests that a more effective constraint to budgetary discipline arises within full-fledged unions in operation over long periods, even in the absence of binding central rules on government deficit and debt positions.     

Excess returns in the EMS: Do “weak” currencies still exist after the widening of the fluctuation bands?

Excess Returns in the EMS: Do “Weak” Currencies Still Exist after the Widening of the Fluctuation Bands? — The authors analyze the issue of how the different institutional arrangements within the ERM have affected the behaviour of excess returns on DM-denominated assets and contribute to the debate on the future of the EMS. Their approach consists in estimating simple forecasting models for interest differentials, and testing for the presence of significant (negative) mean prediction errors. The comparison between predicted and actual outcome indicates that the new system might be characterized by the virtual disappearance of “weak” currencies, as the widening of the bands has removed the expectations of realignments which resulted in high interest differentials.