European European Macro-economic Macro-economic

CooperationCooperation

Topics CoveredTopics Covered

Macro-economic cooperation under the Macro-economic cooperation under the Rome Treaty.Rome Treaty.

Autonomy versus cooperation in a Autonomy versus cooperation in a Mundell-Fleming model.Mundell-Fleming model.

New approaches to macro-economic New approaches to macro-economic policy making.policy making.

The European Monetary System.The European Monetary System.

Why beyond the EMS.Why beyond the EMS.

Macro-economic cooperation under Macro-economic cooperation under the Rome Treatythe Rome Treaty

Relations are characterisedRelations are characterised

1.1. Heavy conditionality of the liberalisationHeavy conditionality of the liberalisation

2.2. A lack of binding commitments for A lack of binding commitments for macropolicy makersmacropolicy makers

3.3. Open-ended escape and safeguard Open-ended escape and safeguard clausesclauses

Two key ingredients have changed Two key ingredients have changed since the 1960s.since the 1960s.

First , After demise of Bretton Woods in First , After demise of Bretton Woods in 1971, flexible exchange rates became 1971, flexible exchange rates became much more populer and the EC faced the much more populer and the EC faced the issue of opting for a ‘joint float’(with issue of opting for a ‘joint float’(with internal pegs).internal pegs).Second , Economic analysis and policy Second , Economic analysis and policy experiences have thoroughly altered the experiences have thoroughly altered the conduct of macro-economic in EC conduct of macro-economic in EC countries.countries.

Autonomy versus cooperation in a Autonomy versus cooperation in a Mundell-Fleming modelMundell-Fleming model

Effectiveness of fiscal and monetary policiesEffectiveness of fiscal and monetary policies

Fiscal expansionFiscal expansion Monetary expancionMonetary expancion

FixedFixed

Exchange ratesExchange rates

Zero/low capital moderately effective ineffectiveZero/low capital moderately effective ineffective

MobilityMobility

High/perfect very effective ineffectiveHigh/perfect very effective ineffective

Capital mobilityCapital mobility

FlexibleFlexible

Exchange ratesExchange rates

Zero/low capital moderately effective effectiveZero/low capital moderately effective effective

MobilityMobility

High/perfect ineffctive very effective High/perfect ineffctive very effective

Capital mobilityCapital mobility

Mondel-Fleming FrameworkMondel-Fleming Framework

Monetary policy is used for external Monetary policy is used for external balance, and fiscal policy is used for balance, and fiscal policy is used for internal balance at this model.Which is internal balance at this model.Which is better for its politics(interest) it is preferred.better for its politics(interest) it is preferred.

New approaches to macro-New approaches to macro-economic policy makingeconomic policy making

The ‘New classical’ macro-economics is The ‘New classical’ macro-economics is based on four main ideasbased on four main ideas

1.1. Explicit attention for the supply side.Explicit attention for the supply side.

2.2. Prices and wages change, and their Prices and wages change, and their responsivness to other variables responsivness to other variables (or stickiness) should be modelled.(or stickiness) should be modelled.

3.Rational expectations about prices, 3.Rational expectations about prices, interest rates, exchange rates and interest rates, exchange rates and wages; in other words, the future price wages; in other words, the future price level should be modelled in such a way level should be modelled in such a way that it is consistent with the information that it is consistent with the information (economic agents are supposed to (economic agents are supposed to possess) in the model.possess) in the model.

4. Credibility of policies announced by the 4. Credibility of policies announced by the authorities, especially with respect to authorities, especially with respect to (lowering) inflation and maintaining a (lowering) inflation and maintaining a certain exchange rate or target zones, are certain exchange rate or target zones, are related to expectations alter only slowly related to expectations alter only slowly since a reputation of credibility (espesially since a reputation of credibility (espesially about disinflation) has to be ‘earned’.about disinflation) has to be ‘earned’.

Monetary and fiscal policy Monetary and fiscal policy effectiveness in new classical effectiveness in new classical

modelsmodels

Fiscal expansionFiscal expansion Monetary expancionMonetary expancion

FixedFixed

Exchange ratesExchange rates

expected effective ineffectiveexpected effective ineffective

Not anticipated effective ineffectiveNot anticipated effective ineffective

FlexibleFlexible

Exchange ratesExchange rates

expected effective ineffectiveexpected effective ineffective

Not anticipated effective effective (temporary)Not anticipated effective effective (temporary)

The European Monetary SystemThe European Monetary System Characteristing the European Monetary System in 1979Characteristing the European Monetary System in 1979

Elements SpecificationElements Specification

Goal ‘Zone of monetary stability’Goal ‘Zone of monetary stability’

Exchange Between the central banks(not the goverments)Exchange Between the central banks(not the goverments)

Rate Formally outside Community lawRate Formally outside Community law

Mechanism Central rates in ECUMechanism Central rates in ECU

(ERM) İntervention obligations (symmetric)(ERM) İntervention obligations (symmetric)

Re-alignment subject to common agreement Re-alignment subject to common agreement

Credit Automatic,unlimited swap-facilities(up to 45days) Credit Automatic,unlimited swap-facilities(up to 45days)

Facilities between the central banks (called ‘very short term)Facilities between the central banks (called ‘very short term)

Short term fasilities up to 9 months between centralShort term fasilities up to 9 months between central

banks, unconditional (they already existed before)banks, unconditional (they already existed before)

Medium-term credits,conditional upon an applicant’sMedium-term credits,conditional upon an applicant’s

measures to promote ‘economic convergence’, andmeasures to promote ‘economic convergence’, and

subject to an EC Council decisionsubject to an EC Council decision

Reserve 20 per cent of national gold and foreign exchangesReserve 20 per cent of national gold and foreign exchanges

pooling reserves to be deposited for three months, withpooling reserves to be deposited for three months, with

automatik renewal, into the European Fund for Monetaryautomatik renewal, into the European Fund for Monetary

Cooperation Cooperation

EFM could issue ECUs against these deposits (under a EFM could issue ECUs against these deposits (under a

Council Regulation), but only for use among central banksCouncil Regulation), but only for use among central banks

European İntroduced by an EC Regulation European İntroduced by an EC Regulation

Currency ECU isCurrency ECU is

Unit - unit of accountUnit - unit of account

(for ERM - means of payment, only among central banks, but(for ERM - means of payment, only among central banks, but

Countries only) receiver was obliged only to accept a max. of ECUsCountries only) receiver was obliged only to accept a max. of ECUs

- legal tender for the system - legal tender for the system

Divergence Attempt to introduce ‘symmetry’ and coordinationDivergence Attempt to introduce ‘symmetry’ and coordination

İndicator Fixed at 75 per cent of the margin İndicator Fixed at 75 per cent of the margin

The indicator serves as a flashlight ; the country with The indicator serves as a flashlight ; the country with

(for ERM only) the deviating currency being subject to a ‘presumption to(for ERM only) the deviating currency being subject to a ‘presumption to

act’ or otherwise explain in consultations why it did not actact’ or otherwise explain in consultations why it did not act

The changing character of the EMS : 1979 - 95The changing character of the EMS : 1979 - 95Period CharecteristicsPeriod Charecteristics

March ’79 - realignment frequentMarch ’79 - realignment frequent

March ’83 - nominal convergence limitedMarch ’83 - nominal convergence limited

- no reforms- no reforms

- methods(symmetric interventions, credit facilities) barely held EMS together- methods(symmetric interventions, credit facilities) barely held EMS together

April ’83 - realignment less frequentApril ’83 - realignment less frequent

early ’87 - nominal convergence improved steadilyearly ’87 - nominal convergence improved steadily

- no EMS reformsş but Single Act introduced capital market liberalizations- no EMS reformsş but Single Act introduced capital market liberalizations

- more intra-marginal intervations- more intra-marginal intervations

early ’87 - no realignment (until Sept. ’92 crisis)early ’87 - no realignment (until Sept. ’92 crisis)

Sept.’92 - incomplete convergence (in inflation and interest rates)Sept.’92 - incomplete convergence (in inflation and interest rates)

- reforms (Basle-Nyborg and 1st stage EMU)- reforms (Basle-Nyborg and 1st stage EMU)

- more currencies in ERM (UK, Spain, Portugal)- more currencies in ERM (UK, Spain, Portugal)

- exchange controls abolished - exchange controls abolished

Sept.’92 - several realignmentsSept.’92 - several realignments

mid. ’96 - lira and pound out of ERMmid. ’96 - lira and pound out of ERM

- widening of band to (2 X ) 15 per cent- widening of band to (2 X ) 15 per cent

- exchange rate stability / convergence restored in ‘94- exchange rate stability / convergence restored in ‘94

Economic asessment of the EMSEconomic asessment of the EMSKey Word Research question AssessmentKey Word Research question Assessment

Stability successful as a ‘zone of monetary exchange-rate variability sharply reduced up to 1992;Stability successful as a ‘zone of monetary exchange-rate variability sharply reduced up to 1992;

stability inflation strongly reduced, but not clearly due to EMSstability inflation strongly reduced, but not clearly due to EMS

Exchange control exchange rate stability due to capital Helpful short-run device before realignment (whenExchange control exchange rate stability due to capital Helpful short-run device before realignment (when

controls? bigger han band, i.e. 4.5 per centcontrols? bigger han band, i.e. 4.5 per cent

Emprical evidence on insultation very weak up to ‘92 Emprical evidence on insultation very weak up to ‘92

Disinflation EMS reduced the costs of disinflation? No, becauseDisinflation EMS reduced the costs of disinflation? No, because

- emprical evidence for non-EMS not very diffrent- emprical evidence for non-EMS not very diffrent

- Germany can only lose in this thesis- Germany can only lose in this thesis

- exchange controls lower credibility- exchange controls lower credibility

External shocks EMS, a shock-absorber Yes, because External shocks EMS, a shock-absorber Yes, because

mechanismmechanism?? - intra-EC shocks were symmetric - intra-EC shocks were symmetric

- outside shocks no longer prompted divergent - outside shocks no longer prompted divergent

responseresponse

Symmetry was the actual functioning of No, Symmetry was the actual functioning of No, becausebecause the EMS symmetric? - Germany anchor (n-1)the EMS symmetric? - Germany anchor (n-1)

- Germany not totally insulated- Germany not totally insulated

Growth has the EMS caused fiscal Probably not, becauseGrowth has the EMS caused fiscal Probably not, because

policy to be deflationary? - theoretically unlikelypolicy to be deflationary? - theoretically unlikely

- emprical evidence at best ambiguous, if not weak - emprical evidence at best ambiguous, if not weak

Resource: European Integration methods Resource: European Integration methods and economic analysis[Jacques pelkmans]and economic analysis[Jacques pelkmans]