1 Joining a Monetary Union: Europe’s Great Monetary Experiment Eduard Hochreiter Joint Vienna...
-
Upload
edgar-rudolf-glenn -
Category
Documents
-
view
215 -
download
0
Transcript of 1 Joining a Monetary Union: Europe’s Great Monetary Experiment Eduard Hochreiter Joint Vienna...
1
Joining a Monetary Union: Europe’s Great Monetary Experiment
Eduard HochreiterJoint Vienna Institute
Wilfrid Laurier University
Thursday, September 27, 2007
3.00 p.m.
2
Overview
1. Introduction2. A Look at History3. The Architecture of Maastricht incl
Coordination of Macro Policies4. Benefits and Costs of Joining a MU5. Institutional Requirements for Joining EMU6. Economic Issues Regarding The Adoption
of the Euro7. The Adoption of the Euro: The Case of Greece8. Experiences with EMU9. Some general conclusions
3
1. Introduction
Exciting experiment born out of will to prevent wars nourished by market integration entering adulthood with the introduction of the
euro complex political – institutional – economic
interaction; European integration perspective difference to other regions
lecture pinpoints important institutional & economic issues
4
2. European Integration – Europe’s Great Monetary Experiment –
A Brief Look At History - 1
1950: European Payments Union (EPU)
1952: European Coal and Steel Community (ECSC)
1957: Treaty of Rome
1958: European Economic Community (EEC) + EURATOM
1960: European Free Trade Association (EFTA)
1970: „Werner Report“: Create EMU within a Decade
1972: „European Currency Snake“
1979: European Monetary System (EMS)
1986: Single European Act
1990: Stage 1 of EMU
1992: Maastricht Treaty
1993: Single Market for „Four freedoms“ a reality
5
2. European Integration – Europe’s Great Monetary Experiment –
A Brief Look At History - 2
1994: Stage Two of EMU; EMI (European Monetary Institute)
1995: Fixing of starting date of Stage Three of EMU; “Euro”
1997: Amsterdam Treaty - SGP
1998: ECB; decision on 11 initial EMU members
1999: Stage Three of EMU
2001: Greece: 12th Euro Area-member
2002: Issuance of euro coins and banknotes
2004: Ten new EU-MS, mainly from CEE
2007: BG + ROM join EU; Slovenia 13th Euro Area-member
2008: Cyprus and Malta:14th and 15th Euro Area-member
2009: Slovakia becomes the 16th Euro Area-member?Back
7
3. The Architecture of the Maastricht Model - 1
Historical uniqueness of EMU: National states formally give up sovereign monetary policy in peacetime and transfer it to a supranational, independent institution the ESCB.
Maastricht Treaty (MT): Price stability as basic common public good of the EU. The MT enshrines the European “stability culture”.
8
3. The Architecture of the Maastricht Model - 2
Amsterdam Treaty: SGPSGP clarifies and modifies EDP+ establishes an early warning system by setting
up yearly stability programs to be submitted by MS
+ defines medium term budgetary objective of “positions close to balance or in surplus
+ sets strict deadlines for the application of the EDP
+ invites the imposition of sanctions
Reform of the SGP 2005
9
Reform of the SGP 2005-1-
3% (for budget deficit) and 60% (for public debt) reference values remain unchanged.
“Preventive arm“ changes:+ Medium term objective “close to balance or in surplus” (CTBOIS) zero to surplus broadened to – 1% (high growth low debt countries) to zero to surplus (low growth high debt)and CTBOIS now country-specificImplies: European Commission now more room for discretion and interpretation+ More symmetric “consolidation in good times”+ No EDP when G-deficit > 3%, if overshooting due to temporary factors and “remaining close to the reference value” Long list of temporary deviations from MT objective (e.g.: structural reforms)
10
Reform of the SGP 2005-2-
“Corrective arm” changes:+ No triggering of EDP, if economic growth contracts by more than 2%. Broadened to" negative growth or a period of low growth”+ Long list of exceptional circumstances, e.g.: cyclical position, R&D, financial contributions to foster international solidarity, the unification of Europe, etc.+ Minimum fiscal adjustment 0.5% p.a., if not CTOBOIS+ Extension of deadlines of EDP+ Repeating of procedural steps possible+ Extension of correction period 2 years (Portugal 3 years already!!)
Back
11
3. The Architecture of the Maastricht Model - 3
Monetary Policy centralized at euro area level and oriented towards an area-wide objective: the maintenance of price stability (defined by the System itself).
Fiscal Policy predominately remains in the national domain, subject to the Treaty constraint that national economic developments must not influence monetary conditions in the euro area in a negative way.
GUIDING PRINCIPLES: “sound public finances” [Art 4(3)]; economic policies a
matter of common concern (Art. 99) No bailout clause (Art. 103) EDP (Art. 104) --- Maastricht Treaty SGP (Council Regulations 1466/97, 1467/97 and Council
Resolution 97/C236/01-02) --- Amsterdam Treaty
12
3. The Architecture of the Maastricht Model - 4
2 major issues: Question: Are there sufficient incentives for sound
fiscal policies in EMU AFTER the adoption of the euro? What are “sound”, i.e. sustainable fiscal policies? Fiscal rules and coordination among fiscal policies
Question: How to secure the consistency of (only loosely coordinated) national fiscal policies with the area-wide stability-oriented monetary policy. Is there a case for ex ante coordination between fiscal
and monetary policies?
13
3. The Architecture of the Maastricht Model:
What are sound, i.e. sustainable fiscal policies?
= change in government debt at time t
g = government expenditure exclusive of interest payments
t = government revenue except seigniorage
= „net“ interest payments, i.e. difference between the nominal interest rate and nominal GDP growth
= change in monetary base = seigniorage
ttytttt mbyitgb
)()(
)( yt yi
tb
tm
Back
14
3. The Architecture of the Maastricht Model - 5
(ad 1): Potential conflicts among national fiscal policies. How to discipline fiscal policy? Do we need fiscal rules in EMU? Problem 1: excessive deficits in one region spread over
the union: incentive for governments to overspend (in SR) externalization of fiscal excesses [smaller rise in interest rate]: FREE RIDING PROBLEM
Problem 2: if so, bailout? (in LR) to avoid bankruptcy potential cost of bailout spread over the union [smaller rise in inflation]: MORAL HAZARD PROBLEM
HENCE: (binding) fiscal rules (of some kind, e.g. SGP) recommended on economic grounds to avoid lax fiscal policies.
15
3. The Architecture of the Maastricht Model - 6
Coordination of fiscal and monetary policies:
The economics debate: How are fiscal and monetary
policies related?
Monetary and fiscal policy are linked through the intertemporal budget constraint (expected sum of expenditure = exp. sum of revenues); in EMU seigniorage is exogenous for govt.; hence budget constraint must be met in LR to avoid bankruptcy.
16
3. The Architecture of the Maastricht Model - 7
What does theory tell us regarding the benefit/need to ex ante coordinate fiscal and monetary policy? In simple two-player game theoretic models it can be shown
that policy coordination improves the policy outcome (move from non-cooperative to bargaining equilibrium raises welfare; reduction of spillover effects)
BUT: Who takes the lead in fiscal policy in EMU? Will all the other (fiscal) players fall in line? Are all players symmetrically informed? Is the economic model agreed?
How sizeable are the welfare gains?
Many uncertainties!
17
3. The Architecture of the Maastricht Model - 8
Is there a need for fiscal rules?+ Static macro model: IS-LM are independent NO+ Neoclassical perspective: if Riccardian equiv. holds or, if not, financial markets are efficient (sovereign credit risk is reflected in risk premia) NO+ Dynamic macro model = Maastricht Model: UMA (Sargent-Wallace) turns into UFA (Winckler-Hochreiter-Brandner) YES + Fiscal theory of the price level: in the case of a fiscal shock monetary policy, ultimately, must produce enough (inflation tax) revenue for the state to remain solvent (see formula above) = fiscal dominance NO
ALTERNATIVELY: reduce G or raise T to secure the LR solvency of the state (see formula above) = monetary dominance
18
3. The Architecture of the Maastricht Model - 9
Fiscal policy surveillance and coordination: Multilateral surveillance of fiscal policies:
European Commission Coordination through ECOFIN = institutional
flaw as ECOFIN decides on existence of ED, the measures to be taken and the sanctions levied!
Central instrument of policy coordination: BEPGs under the Mutual Surveillance Procedure (Art. 99)
comprises the guiding principles of economic policy making in a medium term perspective of 3 years for the EU, euro area and each MS.
Back
19
4. Benefits and Costs of Joining a MU
- 1 -
Benefits: Lower transaction costs (OCA) trade effects
(beyond that of fixed exchange rates) – Rose 2000, Glick & Rose 2001, Frankel & Rose 2002.
Other micro efficiency gains (no exchange rate risk; lower interest rate differential; deeper financial integration; seigniorage gain through international use of currency (€).
Higher business cycle sycronicity endogeneity of OCA
More real growth and reduced output and inflation variability
20
4. Benefits and Costs of Joining a MU
- 2 -
Costs:
Loss of monetary policy instrument Loss of seigniorage Higher real exchange rate persistence Cost of asymmetric shocks
21
4. Benefits and Costs of Joining a MU
- 3 - Assessment for Europe (Hochreiter et. al, 2002, Table 2).
BENEFITS: savings on transaction costs: (EC 1990: forex + interbank
transactions: + 0.5% p.a.; R. Mendizábal 2006: + 0.69% p.a. max.)
other micro gains: all positive impact on growth; most: financial deepening substantial growth effects: > + 0.5% p.a.
higher BC synchronization (Böwer and Guillemineau 2006; and lower volatility (EC 2007).
growth benefits beyond that of fixed exchange rates through single currency „Rose Effect“, i.e. tripling of trade (Rose 2000), + 30 to + 90 % trade growth for Euro Area (Rose and Stanley 2005).
additional seigniorage through international use of currency small
22
4. Benefits and Costs of Joining a MU
- 4 -
COSTS: loss of autonomy for monetary policy: can also be
a blessing (e.g., Greece; Hochreiter & Tavlas 2005);
asymmetric shocks: negligible for most EU members; but, possibly size-related (sticky domestic adjustment mechanisms).
(Net) Loss of seigniorage: negligible, if at all.
Back
23
5. Institutional Requirements of The Adoption of the Euro:
The Maastricht Convergence Criteria - 1
EMU membership is part of the legal EU Treaty framework, the "Acquis communitaire".
Hence, with EU entry also EMU and ESCB membership, but “with a derogation”
Euro adoption a right AND a Treaty obligation (no opt-out clause)
precondition for euro adoption: fulfillment of Maastricht convergence criteria
24
5. Institutional Requirements of The Adoption of the Euro:
The Maastricht Convergence Criteria - 2
1. Inflation criterion: an (sustainable) inflation rate not more than 1 1/2% higher than those of the three best performing EU countries (EU 27!!) over the latest 12 months. Does this make sense in EMU?
1. Fiscal convergence criteria: (a) a general government budget deficit of not more than 3 % of GDP, unless either the reference value was exceeded only temporarily or exceptionally and remains close to the reference value, or the ratio has declined substantially and continuously and reached a level close to the reference value. Too restrictive? not enough room for manoeuvre? Procyclical?
25
Derivation of 3% deficit reference value:
p
whered = level of debtbp = primary balanceb = overall balancei = nominal interest rater = real interest rate = rate of inflationge = government expenditureg = real growth ratet = taxes
p
Back
26
5. Institutional Requirements of The Adoption of the Euro –The Maastricht
Convergence Criteria - 3
(b) a government debt ratio of not more than 60 % of GDP unless the ratio is approaching that level at a satisfactory pace. not enough emphasis on level of debt?3. Interest rate criterion: an average nominal long term interest rate that does not exceed by more than two percentage points that of the three best performing member states in terms of price stability. not really controversial4. Exchange rate criterion: participation in the Exchange Rate Mechanism (ERM II) of the European Monetary System (EMS) within the normal fluctuation margin without severe tensions for at least two years and without having requested a devaluation. useless or even counterproductive?
27
Accession Criteria - 1
Country
Government
deficit to GDP
Government debt to GDP
max 3.0% max. 3%
max. 60%
min. ERM II stay: 2 years max 6.4% NA NA NA NA
Denmark 2.10% -3.90% 30.0% 1-Jan-99 5.20% opt-out not yet set NA none yet
Sweden 1.50% -2.00% 50.9% 0 years 3.70% yes not yet set NA none yet
United Kingdom 2.20% 4.00% 42.2% 0 years 5.00% opt-out NA NA none yet
ERM II membership
sinceReference value (as of May 2007)
Convergence criteria Target date
Euro coins designInterest rate
Set by the country
Recommended by the
Commission
Obligation to adopt
Inflation rate
Government finances
Source: European Commission
28
Accession Criteria - 2
Country
Government
deficit to GDP
Government debt to GDP
max 3.0% max. 3%
max. 60%
min. ERM II stay: 2 years max 6.4% NA NA NA NA
Bulgaria 4.60% -3.10% 29.9% 0 years 3.80% yes 2009-2010 NA in progress
Cyprus 2.00% 1.50% 65.3% 2-May-05 4.20% yes 1/1/2008 1/1/2008 ready
Czech Republic 2.20% 3.60% 30.4% 0 years 3.80% yes not yet set NA in progress
Denmark 2.10% -3.90% 30.0% 1-Jan-99 5.20% opt-out not yet set NA not yet
Estonia 4.30% -2.30% 4.5% 28-Jun-04 -4.10% yes 2010 To be announced ready
Hungary 3.50% 10.10% 61.7% 0 years 7.10% yes 2010-2014 NA in progress
Latvia 6.70% -0.10% 12.1% 2-May-05 3.90% yes 2010-2012 To be announced ready
Lithuania 2.70% 0.50% 19.7% 28-Jun-04 3.70% yes 2010 To be announced ready
Malta 2.20% 2.60% 66.5% 2-May-05 4.30% yes 1/1/2008 1/1/2008 ready
Poland 2.30% 3.70% 47.0% 0 years 4.25% yes 2012 NA in progress
Romania 4.00% 2.50% 20.3% 0 years 8.00% yes 2014 NA none yet
Slovakia 4.30% 3.10% 34.5% 28-Nov-05 4.30% yes 2009 To be announced ready
Euro coins
designInterest rate Set by the
country
Recommended by the
Commission
Obligation to adopt
ERM II membership
sinceReference value (as of May 2007)
Convergence criteria Target date
Inflation rate
Government finances
Source: European Commission
29
Accession Criteria - 3
Back
Country
Government
deficit to GDP
Government debt to GDP
max 3.0% max. 3%
max. 60%
min. ERM II stay: 2 years max 6.4% NA NA NA NA
Croatia2.70% 2.20% 40.8% 0 years NA NA NA NA
Republic of Macedonia 3.20% 0.60% 39.5% 0 years NA NA NA NA
Turkey9.50% 0.60% 60.7% 0 years 10% NA NA NA NA
Albania2.40% 0 years NA NA NA NA
Bosnia and Herzegovina 0.90% 0 years NA NA NA NA
Serbia0 years NA NA NA NA
Montenegro 0 years NA NA NA NA
Euro coins
designInterest rate Set by
the country
Recommende
d by the
Commission
Obligation to adopt
ERM II membership
sinceReference value (as of May 2007)
Convergence criteria Target date
Inflation rate
Government finances
Source: European Commission
30
6. Economic Issues Regarding The Adoption of the Euro -1
Fast or slow?
+ If net gains large and costs falling over time quick adoption
+ If benefits and costs balanced and benefits rise over time take your time
+ All subject to fulfillment of Maastricht criteria!
31
6. Economic Issues Regarding The Adoption of the Euro - 2
Some major issues:
+ (Prudent) Fiscal positions (e.g.: Hungary)
+ Inflation (-differentials) Balassa-Samuelson effects (e.g.: Estonia, Lithuania)
+ Capital flows (Sudden stops and reversals)
+ Financial sector development
32
6. Economic Issues Regarding The Adoption of the Euro - 3
Vulnerabilities+ Capital account volatility (policy inconsistency, asymmetric shocks, exit date risks)+ Credit booms+ Economic booms
Possible strategies to minimize risks up to the €+ reduce fiscal deficits, contain inflationary pressures and maintain growth (structural adjustment)
33
6. Economic Issues Regarding The Adoption of the Euro - 4
Entry into &Time spent in ERM IINew EMS can join ERM II any time after EU accession. “training room” - or “waiting room” approaches
Strategies:+ Adopt Euro as soon as possible and in ERM II as late as necessary (i.e. > 2 years before+ Participate in ERM II as soon as possble and then take time to prepare for Euro adoption+ „Wait and See“ approach
Risks of (untimely) ERM II entry:+ Risk for too tight a corset+ Risk for too loose a corset+ Risk of speculative attacks
Back
34
7. The Adoption of the Euro: The Case of Greece - 1
Greece: EU 1981, at the time an EME at best (low income, high volatility, underdeveloped financial markets, etc.), highly regulated, capital controls, quite closed economy, political business cycles, structural rigidities.
Until mid-1990s inconsistent policies, fiscal dominance, futile search for nominal anchors (independent monetary policy an asset?), speculative attacks, currency crises, current account driven balance of payments crises; wage excesses, huge, persistent disequilibria, key economic indicators 1981 – 1995: average inflation rate ~ 20 % p.a., average budget deficit ~ 10% p.a., public debt from <20% to ~ 120% of GDP average real growth ~1 % p.a.
35
7. The Adoption of the Euro: The Case of Greece - 2
1995: Fundamental political decision to pursue policies that will allow Greece to introduce the euro in 2001 fundamental, sustained policy shift, anchored at Maastricht: stability-oriented monetary policy: (pre-announced) “hard
currency peg”), fiscal consolidation, tight prudential regulation and supervision of banks, structural adjustment (privatization, wage bargaining
processes, deregulation, financial market liberalization). 1998: ERM entry AFTER policies set and intended euro
adoption date (2001) credible! Strong political will, broad political support, and adequate
economic policies DECISIVE
36
7. The Adoption of the Euro: The Case of Greece - 3
ERM entry (March 1998) with a devaluation
Thereafter: significant Drachma appreciation with some volatility; but very smooth exchange rate development as of spring 1999!
Credibility of maintaining adequate policies Credibility of endpoint/exit! (+ conversion
rate)
37
7. The Adoption of the Euro: The Case of Greece - 4
Svensson test for Greece
Greek 10y-Interest Rate Bands Implied by Broad EMS Bands
0%
5%
10%
15%
20%
25%
1993
M1
1993
M6
1993
M11
1994
M4
1994
M9
1995
M2
1995
M7
1995
M12
1996
M5
1996
M10
1997
M3
1997
M8
1998
M1
1998
M6
1998
M11
1999
M4
1999
M9
2000
M2
2000
M7
2000
M12
GDR 10y max GDR 10y rate GDR 10y min
10
1
*1
ttt S
Sii
Back
38
7. The Adoption of the Euro: The Case of Greece - 5
March 16, 1998: Central rate: ECU/EUR 1 = GRD 353.109 January 17, 2000: New CR = GRD 340. 75 = Conversion rate
GRD/Euro(ECU)
300.00
310.00
320.00
330.00
340.00
350.00
360.00
01.0
1.1
998
01.0
3.1
998
01.0
5.1
998
01.0
7.1
998
01.0
9.1
998
01.1
1.1
998
01.0
1.1
999
01.0
3.1
999
01.0
5.1
999
01.0
7.1
999
01.0
9.1
999
01.1
1.1
999
01.0
1.2
000
01.0
3.2
000
01.0
5.2
000
01.0
7.2
000
01.0
9.2
000
01.1
1.2
000
01.0
1.2
001
GRD/Euro-Spot GRD-Central Rate
Introduction of the EuroERM I-entry
Revaluation
Back
39
7. The Adoption of the Euro: The Case of Greece - 6
What about (independent) use of monetary policy in the run-up to the euro?+ Recall Impossible Trinity: fixed exchange rates and open capital account no monetary independence!
But, Greece: Use of tight monetary policy to reach inflation cri
terion until late 2000.
High real interest rates did cause significant capital inflows; sterilizing interventions bought time at the cost of come 0.5% of GDP.
40
The Impossible Trinity
Free Capital Movements
Pegged Exchange Rate
Independent Monetary Policy
Use monetary policy to maintain exchange rate peg
Let exchange rate floatto maintainmonetary independence
Capitalcontrols
Back
41
7. The Adoption of the Euro: The Case of Greece - 7
Three-Month Money Market-Spread(GRD minus DEM)
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
Jän.9
8
Mär.
98
Mai.9
8
Jul.9
8
Sep.9
8
Nov.9
8
Jän.9
9
Mär.
99
Mai.9
9
Jul.9
9
Sep.9
9
Nov.9
9
Jän.0
0
Mär.
00
Mai.0
0
Jul.0
0
Sep.0
0
Nov.0
0
Jän.0
1
Back
42
7. The Adoption of the Euro: The Case of Greece - 8
Conclusions on Greek experiences:
EMU provides the special circumstances to make the middle to be stable.
Only enter ERM II once convergence policies are CREDIBLY enacted and on track.
Importance of credible exit date and common view on conversion rate
Back
43
8. Experiences with EMU- 1 -
Positive results How to deal with heterogeneity in EMU?
+ Growth divergence
working of adjustment mechanisms
+ Inflation divergence
matter for concern or a normal phenomenon?
endogeneity of OCA criteria (labor mobility, fiscal transfers)
Back
46
9. Some General Conclusions - 1
EMU is a unique experiment combining a supranational monetary policy with still national, albeit loosely coordinated, fiscal policies.
EMU has a very important political dimension. Sets it aside from other regions thinking about a MU.
Policy coordination in EMU and EU mostly is about coordination among fiscal policies and between fiscal and other economic policies and NOT between fiscal and monetary policies.
47
9. Some General Conclusions - 2
The Maastricht Treaty stipulates that in case of inconsistencies between fiscal and monetary policy the former has to yield to the latter: the Maastricht framework is one of monetary dominance as opposed to fiscal dominance.
The Treaty does not foresee ex ante co-ordination between fiscal and monetary policies.
Greece offers some useful insights for EU countries that as yet have not adopted the Euro.