Fiscal constraints and financial regulation in economic and monetary union

It is already well understood that economic and monetary union (EMU) will imply the centralisation of much of economic policy, including the setting of the euro interest rate and restrictions on the fiscal freedom of participating countries. In this article it is argued that fiscal harmonisation will go further than an obligation to adhere to the deficit limit of the'convergence criteria': It is also deduced that central control over the regulation of financial institutions will be necessary for EMU to function.     

A small monetary system for the euro area based on German data

Previous euro area money demand studies have used aggregated national time series data from the countries participating in the European Monetary Union (EMU). However, aggregation may be problematic because macroeconomic convergence processes have taken place in the countries of interest. Therefore, in this study, quarterly German data until 1998 are combined with data from the euro area from 1999 until 2002 and these series are used for fitting a small vector error correction model for the monetary sector of the EMU. A stable long‐run money demand relation is found for the full sample period. Moreover, impulse responses do not change much when the sample period is extended by the EMU period provided the break in the extended data series is captured by a simple dummy variable. Copyright © 2006 John Wiley & Sons, Ltd.     

How to rescue European monetary union

This paper considers recent comment and discussion on monetary union in Europe, and appraises recent steps towards Union. It is plain that politics is blinding both supporters and opponents of EMU to issues of major importance, and is also leading them often to'talk past each other'in debate. In the light of this, the article reappraises our earlier proposal for running the euro as a'parallel currency'with national currencies. We suggest that this could still be a sensible strategy for the'outs'and a fall-back if the politicians managed to wreck what could have been a worthwhile venture - a possibility that has been highlighted by events at the early May meeting.     

Financial crisis risk,ECB “non-standard” measures,and the external value of the euro

I study the impact of banking and sovereign debt crisis risk of EMU member states on the external value of the euro. Using a regime switching model, I find that the external value of the euro has significantly responded to financial crisis risk during the period of November 2008–November 2011, while no significant effect is found for the period from February 2006 to October 2008. This suggests that the monetary expansion and interest rate cuts associated with the ECB's “non-standard” measures may have reduced the external value of the euro.     

The merit of a Canada-US monetary union

Institutions of a monetary union are described. The union leaves unchanged countries’ international competitiveness and national real incomes. Static gains arise from lower interest rates in Canada and Mexico because national monetary and exchange rate instability are eliminated. There will be lower costs of foreign exchange transactions. Dynamic gains arise in the form of greater labor market discipline, better signals about developing comparative advantage and higher economic growth. Traditional criteria for the optimality of monetary union are considered irrelevant because they rely on economic characteristics, which are endogenous to the monetary system in operation.     

Exchange rate regimes and capital mobility: issues and some lessons from central and eastern European applicant countries☆

The five most advanced central and eastern European countries that aspire to join the European Union, EMU and to adopt the euro, have pursued very dissimilar exchange rate strategies up to now. Yet, there is only one instance in which a country was unable to sustain its chosen exchange rate regime. This paper explores two keys to exchange rate sustainability and argues that failure to maintain internal policy consistency and policy credibility is decisive in forced exit. The paper then relates the findings to possible policy lessons for emerging market economies in the Western Hemisphere.     

Monetary union: European lessons,Latin American prospects

This paper analyzes the long-run sustainability of monetary unions. We infer from the EMU experience that for monetary union to be sustainable, fiscal policy rules are necessary. That does not imply a formal Stability Pact, however. Labor market flexibility is more important for sustainability than cross-border labor mobility. Sound financial markets are another precondition. Lessons for Latin America and the Caribbean include, first, that the benefit-cost balance of a shift to monetary union is much less favorable in Latin America and the Caribbean than in Europe and, most important, that the region is some distance away from satisfying the necessary conditions for monetary union. That leaves dollarization as a limited option for small countries and floating rates combined with inflation targeting for much of the rest.     

EMU without Britain: reasons for scepticism

This paper applies the theory of optimum currency areas to the question of which countries could be expected to be successful members of EMU if the monetary union does not include Britain, and is therefore led by the Bundesbank. Correlation matrices are prepared for potential members of EMU for recent years to see which countries would have tended to agree on a monetary policy and which would frequently disagree. The statistics strongly suggest that the Bank of England would be a far more successful leader of EMU than would the Bundesbank. Only Austria and the Netherlands have had macroeconomic cycles which closely follow those of Germany. Far more countries have had cycles which parallel those of Britain. With EMU being led by the Bundesbank, because Britain has not joined, the prospects for monetary union are quite poor.     

Global monetary instability: The role of the IMF,the EU and NAFTA

This paper argues that the global monetary system has exhibited significant instability since the collapse of the Bretton Woods regime in 1971. The current challenge for economists and policy makers is the creation of a global monetary system that offers greater exchange rate stability without sacrificing international capital mobility. This paper proposes a solution that consists of three components. First, strengthening the international financial architecture to bring stability, primarily to emerging nations. Second, eventually creating a monetary union in NAFTA and extending it to other countries of the Western Hemisphere to bring stability to this region à la the European Monetary Union (EMU). Third, coordinating economic policies among the U.S., EU and Japan to stabilize these three key global currencies.     

Exchange rate volatility and growth in small open economies at the EMU periphery

Since the introduction of the euro in January 1999, exchange rate stability in the periphery of the euro area is growing. The paper investigates the impact of exchange rate stability on growth for a sample of 41 mostly small open economies at the EMU periphery. It identifies international trade, international capital flows and macroeconomic stability as important transmission channels from exchange rate stability to more growth. Panel estimations reveal a robust negative relationship between exchange rate volatility and growth for countries in the economic catch-up process with open capital accounts.     

Responses to monetary policy shocks in the east and the west of Europe: a comparison

This paper compares impulse responses to monetary policy shocks in the euro area countries before the EMU and in the New Member States (NMS) from central–eastern Europe. We mitigate the small‐sample problem, which is especially acute for the NMS, by using a Bayesian estimation that combines information across countries. The impulse responses in the NMS are broadly similar to those in the euro area countries. There is some evidence that in the NMS, which have had higher and more volatile inflation, the Phillips curve is steeper than in the euro area countries. This finding is consistent with economic theory. Copyright © 2009 John Wiley & Sons, Ltd.     

National natural rates of interest and the single monetary policy in the euro area

We estimate time‐varying national natural real rates of interest (r^?) for the four largest economies of the euro area over 1999–2016. We further derive the associated national real interest rate gaps, which gauge the perceived monetary policy stance in each country. We find that the average r^? have been lower after 2008. Furthermore, national r^? were significantly negative in southern countries during the sovereign crisis. As their effective real rates soared, national rate gaps across the euro area diverged. However, a common policy stance has been restored since 2014 as the European Central Bank's unconventional programs gathered pace.     

Alternative exchange-rate regimes: The options for Latin America

The debate on the optimal exchange-rate regime has been rekindled by the arrival of the euro and the rash of crises in Latin America and elsewhere. This paper reviews the key issues and assesses the state of play in the debate. This provides the context for the other papers in the group, prepared for a conference on “ Monetary union: Theory, EMU experience, and prospects for Latin America,” which took place in Vienna in April 2002 and which was co-sponsored by the Banco de Chile, the Oesterreichische Nationalbank, and the University of Vienna. The papers selected for this issue deal with exchange-rate problems in the Western Hemisphere, and Latin America and the Caribbean (LAC), in particular. After assessing the debate over floating rates versus currency union, the paper examines the issue in the context of monetary relations between the U.S. and Canada. It concludes with an empirical measure of convergence among the countries in the hemisphere.     

The Impact of Shocks on the UK Economy in and Out of EMU

Entry to EMU at an inappropriate exchange rate could trigger a full-blown business cycle in the UK. Once inside EMU, the UK's response to a number of different economic shocks would change — partly because of the fixed exchange rate, and partly because of the common monetary policy. In particular, when an asymmetric shock occurs — one that hits the UK harder than other Eurozone economies — the UK response is generally likely to be more pronounced inside EMU than outside. We find that that result still applies even in a reformed EMU — one in which the ECB and the labour market are reformed to bring them closer to the Anglo–Saxon model.     

Britain,EMU and the European economy

In January 1999, 11 member countries of the European Union ‘irrevocably’ locked the foreign exchange values of their currencies to the euro, and they committed themselves to abandon their currencies in favour of the euro in 2002. As a result, these countries ceased to operate independent monetary policies. Monetary policy for the whole euro‐zone became the responsibility of the European Central Bank (ECB), whose primary objective is to maintain a low and stable rate of price inflation for the euro currency. The rules governing Economic and Monetary Union (EMU) were laid down in the treaty of Maastricht in 1992. As conditions for entry to EMU, the treaty specified ‘convergence criteria’ which consisted of upper limits for several macroeconomic aggregates including, notably, a 3 per cent maximum for the ratio of the public sector deficit to GDP and 60 per cent for the ratio of public debt to GDP.1 In February 1998 the 11 applicant countries submitted statistical analyses relating to their satisfaction of these conditions. Despite doubts as to whether some of them had strictly met the conditions, the European Commission deemed them all eligible, and the euro was launched.2 The British government, though more clearly eligible than most other EU countries on the basis of the convergence criteria, decided to defer its decision on entry. In this paper we consider the arguments for and against Economic and Monetary Union, and in particular whether it would be in Britain’s interest to join. We begin with a brief review of the state of the European economy and an analysis of the first year performance of the new Euro currency. 1 Upper limits were also set on the rate of inflation, at 1.5 percentage points above the average inflation rate of the three countries whose inflation was the lowest, and on long term interest rates, at 2 percentage points above the average of the rates prevailing in the three low inflation countries. An additional condition applied to exchange rate stability relative to the EU average for the two years prior to entry.
1 Notable cases were Belgium and Italy with debt to GDP ratios of 122.2 per cent and 121.6 per cent, respectively. Presumably, these countries were allowed membership under Article 104c(2) of the treaty which allows the debt to GDP ratio to be exceeded if ‘. . . the ratio is sufficiently diminishing and approaching 60 per cent at a satisfactory pace’. The reader is left to judge whether Belgium and Italy fell within the ‘spirit’ of this article.
     

Monetary unions—a superior alternative to full dollarization in the long run☆

The paper extends the debate about the exchange rate system that is appropriate in view of the pressures for currency consolidation in open international financial markets to the issue of full dollarization versus (multilateral) monetary union. Unilateral dollarization may not be sustainable politically in the long run because fully dollarized countries may not be willing to keep on paying a seignorage tribute to the United States once they have built a record of internal stability. Even in the short and medium term, fulfillment of the fiscal and regulatory adjustments and reforms required for multilateral monetary union is preferable to embarking on unilateral dollarization without assurance that needed reforms will be supported by the country’s main constituencies.     

The Conduct of Monetary Policy Without Monetary Aggregates

A central dilemma for the monetary authorities is how to determine monetary policy. The increasing unreliability of monetary aggregates has led over the past few years to less concern for monetary targeting, both in the UK and elsewhere, and a greater influence for the exchange rate on monetary policy. But in the UK, most recently, there has been a move away from setting monetary policy in relation to the exchange rate and external considerations in favour of setting monetary policy in relation to domestic demand. Not surprisingly, this shift has occurred at a time of rising concern about domestic overheating. It illustrates the dilemma of whether monetary policy should be driven by domestic demand considerations or by external, exchange rate considerations. This dilemma is not just confined to the UK for it is a real source of conflict underlying the Louvre Accord and its successors that seek to determine G7 exchange rates in a cooperative manner. In what follows, we argue that exchange rate developments should have an appreciable influence on monetary policy, since this is helpful in attaining stable inflation. But we also suggest that this influence should not go too far, since this stability of inflation may be at the expense of stability of domestic demand and output. Targeting of exchange rates within narrow bands is unlikely to be desirable, unless fiscal policy can be used more flexibly to stabilize domestic demand. This suggests that, in the period up to the spring, the use of monetary policy to hold the £/JDM exchange rate within narrow limits may have been overdone. More seriously, international exchange rate agreements among the G7 countries are likely to founder under adverse market pressures, unless current imbalances in fiscal policy are adjusted. In the absence of greater flexibility in fiscal policy, policy makers will have to trade off domestic and exchange rate considerations in determining monetary policy. An important outstanding issue that needs further consideration is what indicators should be used for monetary policy, in a world in which monetary aggregates provide unreliable signals.     

Mexico versus Canada: Stability benefits from making common currency with USD?

This paper explores the potential stability benefits from monetary union by examining volatility of PPP–GDP per capita and per hour under various de facto exchange rate regimes. It finds that, for Mexico unlike Canada, volatility is much greater during periods when the nominal dollar exchange rate changes appreciably than when it is quasi-pegged. Since Mexico is not in a position to run a credible peg, it must seek greater stability through dollarization. This finding suggests that the stability benefits of monetary union are greatest for emerging-market countries inside an economically integrating region and non-existent for financially highly advanced countries.     

Monetary policy rules for convergence to the Euro

This paper investigates the applicability of open-economy convergence-consistent instrument rules for monetary policies in the economies undergoing monetary convergence to a common currency area. The proposed policy rule is forward-looking, consistent with a monetary framework based on inflation-targeting containing input variables that are relative to the corresponding variables in the common currency area. Robust forms of the policy rule are tested empirically for three inflation-targeting countries converging to the euro, i.e. the Czech Republic, Poland and Hungary. Empirical tests imply systemic differences in monetary policies among these euro-candidates. The Czech monetary policy seemingly follows the rule prescribed by our model. Both the Czech and the Polish central bank interest rate policies respond predominantly to changes in the inflation gap, while the Hungarian responds mainly to the exchange rate gap. In all three cases, changes in the eurozone short-term interest rates strongly drive adjustments in the central banks’ reference interest rates.     

Macroeconomic shocks and fluctuations in African economies

We estimate a monetary DSGE model to examine the role of macroeconomic shocks in generating fluctuations in ten African countries. The model is estimated with the Bayesian technique using twelve macroeconomic variables. The findings indicate that both the internal and external shocks significantly influence output fluctuations in African economies. Over a four quarter horizon, internal shocks are dominant and over eight to sixteen quarter horizons, external shocks are dominant. Among the external shocks, external debt, exchange rate, foreign interest rate and commodity price shocks account for a large part of output variations in African economies. Money supply and productivity shocks are the most important internal shocks contributing to output fluctuations in African countries.