The European Monetary Union READING ASSIGNMENT: McNamara, Kathleen R. 2008. A rivalry in the making?...
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Transcript of The European Monetary Union READING ASSIGNMENT: McNamara, Kathleen R. 2008. A rivalry in the making?...
The European Monetary Union
READING ASSIGNMENT:
McNamara, Kathleen R. 2008. A rivalry in the making? The Euro and international monetary power. International Political Economy 15 (3):439-459.
1
2
The Trilemma
Fixed Exchange Rate
Open Capital Flows
Sovereign Monetary Policy
SwitzerlandPRC
Eurozone countries
2
Recall why a country might want:
• Free Capital Flow?– Draw on the savings of the rest of the world– Investment opportunities abroad
• Fixed Exchange Rate?– Reduce uncertainty in trade
• Sovereign Monetary Policy?– Address inflation/unemployment
3
Plan
4
International Cooperation
• Throughout the semester… disappointment– Little substantial sacrifice of sovereignty– IOs not really fulfilling their stated goals– “dirty work,” “resolve”
• Is real cooperation with genuine sacrifice possible?
YES!
• The Euro represents an ultimate* commitment– *unless they really figure out a way to kick out Greece – (I doubt it)
5
2010
6
Current (2014)From http://en.wikipedia.org/wiki/Template:Supranational_European_Bodies
7
The EU
8
The Euro area
9
Membership
• Some countries, the “Eurozone” doesn’t want (yet/ever?)– Must do the 2 year European Exchange Rate Mechanism
• Some countries don’t want the Eurozone (yet/ever?)– Opt out – Denmark, UK, Sweden (de facto)
• Why?
• A real commitment
• To understand– how it’s a strong commitment – and why some countries want it, – let’s go back…
10
A puzzle:Why were countries able to maintain fixed exchange
rates with high capital mobility in the late 19th century?
1944
Degree of global capital mobility
1971-3
Fixed exchange rates
+
Capital controls
Floating exchange rates
+
Open capital flows
1870 Interwar period
Fixed exchange rates
+
Open capital flows
11
Why?
12
Answer: Democracy
1944
Degree of global capital mobility
1971-3
Fixed exchange rates
+
Capital controls
Floating exchange rates
+
Open capital flows
1870 Interwar period
Fixed exchange rates
+
Open capital flows
Growing #’s of democraciesFew democracies
13
The international collective action problem:
• How can we allow for the free flow of goods, services, and capital without:
– Imbalances leading to beggar-thy-neighbor policies
14
One solution:
• IMF to the rescue!
• Soften the blow of adjustment
• Moral hazard?
• Conditionality?
• Bretton Woods just falls apart…
• The IMF never really worked as intended
15
Maybe not an impossible mission?
• 1979: The European Monetary System
• Fixed but adjustable
• How did it work? – Essentially, the Bundesbank (Germany) used
monetary policy to keep inflation low, and the rest of EMS members fixed to the German mark
16
French-German fight in 1981-3
17
Or: François tests the Adele-hypothesis
• Is the trilemma wrong?
• Can we have it all?
18
French-German fight in 1981-3
• Mitterand – socialist president – believed German monetary policy was strangling
• Expansionist monetary policy (e.g., lowered interest rates)
• French inflation began to rise
• Called on Germany to lower their interest rates
• 18 month stand-off… the French backed down
19
1988-2002: Monetary Union
• 1988: Planning begins
• Gradually moved towards fixing their currency XR’s (1999 – “permanently” fixed)
• Jan 2002: The Euro!
• Why union?
• High degree of economic openness across Europe
• Sacrificed monetary autonomy for XR stability
20
The story of the contemporary international monetary system is the story about the search for the elusive ideal-balance between domestic economic autonomy and exchange rate stability.
21
The point of the unholy trinity – you can’t have it all…
1999: Paul Krugman http://slate.com/id/36764
“The point is that you can't have it all: A country must pick two out of three. It can fix its exchange rate without emasculating its central bank, but only by maintaining controls on capital flows (like China today); it can leave capital movement free but retain monetary autonomy, but only by letting the exchange rate fluctuate (like Britain--or Canada); or it can choose to leave capital free and stabilize the currency, but only by abandoning any ability to adjust interest rates to fight inflation or recession (like Argentina today, or for that matter most of Europe).”
22
Sacrifice
• In the pursuit of free-flowing goods & services, and capital across the borders of Europe…
• Eurozone countries have completely surrendered monetary policy
• Germany’s inflation concerns threatened by Portugal, Italy, Greece, & Spain
• Portugal, Italy, Greece, & Spain’s employment concerns threatened by Germany
• A genuine sacrifice of sovereignty has taken place23
Trade & international capital flows lead to imbalances
• How do governments deal with these imbalances?
1. Avoid them? (Capital controls?)
2. Fixed exchange rate sacrifice monetary policy
OR:
3. Floating exchange rate
Most advanced countries make a trade-off between (2) exchange rate stability – and – (3) domestic price stability with monetary policy autonomy
24
Why are there imbalances?
• These days, foreign exchange markets conduct between $1 trillion and $1.5 trillion worth of business… PER…???
– Per year?
– Per month?
– Per day?
– Per hour?
Exchange rate volatility!
Exchange rate misalignments
25
Consequences of XR volatility?
• Uncertainty may hurt international transactions
26
The Euro
• The ultimate commitment
• So, if it’s credible, will it overtake the dollar as the international reserve currency?
27
28
Good Will Hunting
• SKYLAR: Maybe we could go out for coffee sometime?
• WILL: Great, or maybe we could go somewhere and just eat a bunch of caramels.
• SKYLAR: What?
• WILL: When you think about it, it's just as arbitrary as drinking coffee.
• SKYLAR: (laughs) Okay, sounds good.• http://www.imsdb.com/scripts/Good-Will-Hunting.html
29
Is the Euro an alternative?• Coordination game
• Present distribution of reserve currencies:– Dollar: ~60%– Euro: ~25%– Pound: ~4%– Yen: ~4%– Swiss franc: ~0.1%– Other: 5%
• SDR?30
Be careful what you wish for…
• Benefits of international reserve currency– finance fiscal deficits– enhance international prestige– debt denoted in your own currency
• Costs of international reserve currency– Monetary policy autonomy is hindered - vast
quantities of your currency held abroad– Overvaluation leads to uncompetitive
export-oriented/import-competing sectors
31
Obstacles to the euro
• A focal point: The more people who use an international currency, the more effective it is (increasing returns to scale)
• No equivalent to the US treasury bill @ the EU level
• Leadership – who bails you out?
– US track record v. EU (…Greece?)
32
Is the renminbi an alternative?
33
Is the SDR an alternative?
34
Is the bitcoin an alternative??
35
Status quo
• US “shock absorber”:– Floating exchange rate
• China opts for:– restrictions on capital flows
• How can the dollar adjust if China fixes to it?
• This is the current monetary system…
• And it’s doomed36
Exchange rates & protectionism
• “Currency manipulator” ??
• Should the WTO be involved in regulating the exchange rate?
37
What can China do?
• Gradual appreciation?– A one-way road to “hot money” and a scary bubble
• A one-off revaluation?– Catastrophic economic dislocation– Politically possible given the export-oriented sector
strength?
• Status quo?– Unsustainable in the long-run
38
Take-homes on Euro
• Solves the old problem that the IMF failed to solve
• Still limited as a currency– No EU-level bond
• Will it become the new international reserve currency?
– Probably not any time soon
– Coordination game
– The Dollar is still “noon, Grand Central information booth”
39
Thank youWE ARE GLOBAL GEORGETOWN!
40
A puzzle
1944
Degree of global capital mobility
1971-3
Fixed exchange rates
+
Capital controls
Floating exchange rates
+
Open capital flows
41
Conclusion:
Cannot maintain (global) fixed exchange rates in the presence of
high capital mobility…?
42
A puzzle
1944
Degree of global capital mobility
1971-3
Fixed exchange rates
+
Capital controls
Floating exchange rates
+
Open capital flows
1870
*
43
Keynes 1919 quote:
• “The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery on his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprise of any quarter of the world. He could secure forthwith, if he wished it, cheap and comfortable means of transport to any country or climate without passport or other formality…. He regarded this state of affairs as normal, certain, and permanent.”
44
A puzzle:Why were countries able to maintain fixed exchange
rates with high capital mobility in the late 19th century?
1944
Degree of global capital mobility
1971-3
Fixed exchange rates
+
Capital controls
Floating exchange rates
+
Open capital flows
1870 Interwar period
Fixed exchange rates
+
Open capital flows
45
Eurozone• Austria (1999)• Belgium (1999)• Cyprus (2008)• Estonia (2011)• Finland (1999)• France (1999)• Germany (1999)• Greece (2001)• Ireland (1999)• Italy (1999)• Luxembourg (1999)• Malta (2008)• Netherlands (1999)• Portugal (1999)• Slovakia (2009)• Slovenia (2007)• Spain (1999)
• EU members not using the Euro:– United Kingdom– Denmark– Sweden– Czech Rep Was set to join
Nov 2009… but things changed– Poland– Bulgaria– Hungary– Latvia– Lithuania– Romania
– Legal loophole: Required to join the eurozone after meeting the convergence criteria (including ERM II for two years). But joining ERM II is voluntary.
46
47
My personal idea: a market solution
• Competition for natural resources
• Marginal benefit of protecting exporters
• Meets
• Marginal benefit of cheaper oil
Currency appreciation
• Addresses imbalances… but prices in the US will go up
• Good for the global economy… but hard times ahead for the United States
• Alternative?
– Global catastrophe48