Optimal Currency Areas Scottish Economic Society/Royal Bank of Scotland Annual Lecture, 1999

Microeconomic efficiency and market transparency argue in favour of UK membership in EMU and for Scotland’s membership in the UK monetary union and also in EMU. UK seigniorage (government revenues from money issuance) would be boosted by EMU membership. Lender of last resort arrangements would not be substantially affected by UK membership in EMU. The UK is too small and too open to be an optimal currency area. The same point applies even more emphatically to Scotland. The ‘one‐size‐fits‐all’, ‘asymmetric shocks’ and ‘cyclical divergence’ objections to UK membership are based on the misapprehension that independent national monetary policy, and the associated nominal exchange rate flexibility, can be used effectively to offset or even neutralise asymmetric shocks. This ‘fine tuning delusion’ is compounded by a failure to understand that, under a high degree of international financial integration, market‐determined exchange rates are primarily a source of shocks and instability. Instead, opponents of UK membership in EMU view exchange rate flexibility as an effective buffer for adjusting to asymmetric shocks originating elsewhere. I know of no evidence that supports such an optimistic reading of what exchange rate flexibility can deliver under conditions of very high international financial capital mobility. The economic arguments for immediate UK membership in EMU, at an appropriate entry rate, are overwhelming. Monetary union raises important constitutional and political issues. It involves a further surrender of national sovereignty to a supranational institution, the ECB/ESCB. It is essential that this transfer of national sovereignty be perceived as legitimate by those affected by it. In addition, the citizens of the UK have become accustomed to a high standard of openness and accountability of their central bank since it gained operational independence in 1997. The ECB/ESCB must be held to the same high standard, and, while there are grounds for optimism, there still is some way to go there.     

How successful has stabilization policy been in The Netherlands? A neo-Keynesian perspective

Summary A modern Keynesian perspective is offered on the conduct of monetary, fiscal and exchange rate policy in the Netherlands during the period 1960-1976. A small open macroeconomic model is estimated and simulated under alternative policy rules. Striking features are a strong real balance effect on consumer spending and a significant contribution of exchange rate changes to domestic inflation. Actual policy performs no better as regards the achievement of internal and external balance than simple fixed rules. Both actual policy and fixed rules are dominated by instrument values derived from an explicit optimal stabilization approach. We would like to express our thanks to Bill and Ken Rosen for helpful discussions on estimation and stimulation techniques and to S. Kuipers and H. Verwilst for help in obtaining data. Peter Kenen and S. Kuipers offered detailed comments on an earlier draft.     

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Is Numérairology the Future of Monetary Economics?

The paper discusses some fundamental problems in monetary economics associated with the determination and role of the numéraire. The issues are introduced by formalising a proposal, attributed to Eisler, to remove the zero lower bound on nominal interest rates by unbundling the numéraire and medium of exchange/means of payment functions of money. The monetary authorities manage the exchange rate between the numéraire (‘sterling’) and the means of payment (‘drachma’). The short nominal interest rate on sterling bonds can then be used to target stability for the sterling price level. The paper puts question marks behind two key bits of conventional wisdom in contemporary monetary economics. The first is the assumption that the monetary authorities define and determine the numéraire used in private transactions. The second is the proposition that price stability in terms of that numéraire is the appropriate objective of monetary policy. The paper also discusses the merits of the next step following the decoupling of the numéraire from the currency: doing away with currency altogether—the cashless economy. Because the unit of account plays such a central role in New-Keynesian models with nominal rigidities, monetary economics needs to devote more attention to numérairology—the study of the individual and collective choice processes that govern the adoption of a unit of account and its role in economic behaviour.

Persistent differences in national productivity growth rates with a common technology and free capital mobility: The roles of private thrift, public debt, capital taxation, and policy toward human capital formation

The paper develops a two-country endogenous growth model to investigate possible causes for the existence and persistence of productivity growth differentials between nations despite a common technology, constant returns to scale, and perfect international capital mobility. Private consumption is derived from a three-period overlapping generations specification. The source of productivity (growth) differentials in our model is the existence of a nontraded capital good (“human capital”) whose augmentation requires a nontraded current input (time spent by the young in education rather than leisure). We consider the influence on productivity growth differentials of private thrift, public debt, the taxation of capital and savings, and policy toward human capital formation.     

Ten Commandments for a Fiscal Rule in the E(M)U

Fiscal rules in a monetary union should (1) be simple; (2) ensurethe solvency of the state; (3) relate to the consolidated generalgovernment and central bank; (4) be neutral as regards the sizeof the public sector; (5) avoid pro-cyclical behaviour of thefiscal policy instruments; (6) also make sense in the long run;(7) allow for important differences in economic structure andinitial conditions; (8) aggregate into behaviour that makessense at the level of the union as a whole; (9) be credible;and (10) be enforced impartially and consistently. The paperreviews the rules of the Stability and Growth Pact, the UK'sgolden rule and sustainable-investment rule, and Buiter andGrafe's permanent-balance rule from the perspective of how wellthey meet these ten criteria.     

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.     

Issues in controllability and the theory of economic policy

The paper demonstrates that the concepts of dynamic controllability are useful for the theory of economic policy by establishing four propositions. First, dynamic controllability is a central concept in stabilization policy. Second, the ability to achieve a target state, even if it cannot be maintained, may be of economic interest. Third, dynamic controllability is of special interest for ‘historical’ models. Fourth, the conditions for any notion of dynamic controllability are distinct from and weaker than those for Tinbergen static controllability.