The European Monetary Union

FURTHER READING:

McNamara, Kathleen R. 2008. A rivalry in the making? The Euro and international monetary power. International Political Economy 15 (3):439-459.

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Plan

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What does the Euro have in common with the IMF?

?Both answers to the quest for the elusive ideal balance between stability in international transactions and domestic autonomy

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Imbalances are a fact of global life

• 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

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How do governments deal with these imbalances?

Avoid them? Capital controls!

Fixed exchange rate? Sacrifice monetary policy!

OR:

Floating exchange rate

• Trade-off: exchange rate stability – or – domestic price stability with monetary policy autonomy

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The Euro represents an ultimate* commitment

– *unless they really figure out a way to kick out Greece

– (I doubt it)

– The Euro solution to the TRILEMMA…

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The Trilemma

Fixed Exchange Rate

Open Capital Flows

Sovereign Monetary Policy

The Eurozone

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http://en.wikipedia.org/wiki/Eurozone#Enlargement

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Domestic economic autonomy XR stability

Weak currency

Strong currency

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Sectoral XR preferences summary

XR stability preference

High/fixedlow/float/ monetary

autonomy

XR strength preference

Strong currency

  Nontradable

Weak currency

Export-oriented Import-competing

Financial services

???Exporters in other countries – keep them out of our elections!

Imperialist colonial powers? Get them out of our countries!

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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…

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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

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Why?

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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

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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.”

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The international collective action problem:

• How can we allow for the free flow of goods, service, and capital without:

– Imbalances leading to beggar-thy-neighbor policies

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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

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Maybe not an impossible mission?• 1979: The European Monetary System

• Fixed but adjustable

• The Bundesbank (Germany) used monetary policy to keep inflation low, and other countries engaged in foreign exchange market intervention to fix their currencies to the German mark

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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

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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

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Realignment (against DM) details• UK: 1990/10-1992/9; 1 realignment • Ireland: 1979/3-1993/8; 9 realignments • Netherlands : 1979/3-1993/8; 3 realignments• Belgium: 1979/3-1993/8; (Luxembourg not considered

separately); 8 realignments• France: 1979/3-1993/8; 7 realignments• Spain: 1989/6- 1993/8; 4 realignments• Italy: 1979/3-1992/9; 10 realignments• Portugal: 1992/4-1993/8; 3 realignments• Denmark: 1979/3-1993/8; 9 realignments

Size of individual devaluation: smallest 1% (Belgian franc, 1/1987) to largest 10.6% (French franc, 6/1982)

Overall, non-trivial currency depreciation (1979-1993): Italian lira lost 63%; the French franc 45.2%; Irish pound 41.4%

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Consequences of XR volatility?• Uncertainty may hurt international

transactions

CONCLUSION?• Global “political will” to fix exchange rates

was lacking in 1970s

• But stronger political will to fix exchange rates within Europe

• Narrower group of countries make a deep commitment – sacrifice for cooperation @regional level!

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Thank youWE ARE GLOBAL GEORGETOWN!

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