Mr. Massimo M BeberSenior TutorCollege Lecturer in Economics

Sidney Sussex CollegeCambridge CB2 3HU

mb65@cam.ac.ukhttp://people.ds.cam.ac.uk/mb65/

Arts, Humanities and Social Sciences Summer School 2013

One Market, One Money?The Economics and Politics of European Monetary Union

(http://people.ds.cam.ac.uk/mb65/OneMarketOneMoney.htm)

Mobility of Capital and

Labour

Microeconomic Policy Co-ordination

Common Macroeconomic

Policy

No internal tariffs

Common External Tariff

FREE TRADE AREA y n n n n

CUSTOMS UNION y y n n n

COMMON MARKET y y y n n

SINGLE MARKET y y y y n

EMU y y y y y

Trade in Goods and Services

Source: a version of a Table introduced by Bela Balassa in The Economics of Integration (1961)

ECONOMIC INTEGRATION: A CLASSIFICATION

Europe – A Phase Chronology

• 1945-51: “hegemon-led integration” (Marshall Plan, OEEC-OECD, EPU)

• 1951-1973: “Golden Age regionalism” (ECSC to EEC – customs union, single market in agricuture and coal/steel, first MU blueprint – Werner and MacDougall Reports)

• 1973-1984 “devil take the hindmost”• 1985-1999: “one market, one money”• 2008-?? “Make (banking & fiscal union) or Break”

Landmarks on the Road to EMUJul-50 The European Payments Union begins its operation, facilitating clearing of intra-European payments

Dec-59 With the generalized introduction of "external convertibility", the Bretton Woods system of fixed exchange rates begins to operate.

Dec-69 At the first European Summit in The Hague, the heads of state and government commission the "Werner Report" on a possible European Monetary Union (George Pompidou and Willi Brandt as French President and German Chancellor respectively).

Dec-71 The Smithsonian Agreements effectively signal the demise of the international monetary order based on the "dollar standard".The Agreements included (1) a devaluation of the US $ against other currencies; (2) the abolition of the fixed link between dollar and gold, substituted by one with the SDR; (3) wider fluctuation bands (4.5%).

Dec-72 After 9 months of operation of the "snake in the tunnel", European Summit adopts the goal of economic and monetary union.

Dec-78 European Council's resolution on "creating a zone of monetary stability in Europe".

Mar-79 The European Monetary System (EMS) begins to operate on the basis of an agreement between central banks. Britain does not join the Exchange Rate System (ERM) of the EMS, and remains a floating currency.

Jul-85 Palermo Agreement between Central Bank Governors: the ERM "hardens".

Jun-89 The Madrid European Council endorses the Delors Report commissioned a year earlier at the Hanover Council.

Jun-90 Dublin European Council establishes two ICGs (on political as well as economic and monetary union), with the aim of having new treaties ratified by December 1992.

Oct-90 The UK joins the ERM weeks before Mrs Thatcher's removal from office.

Sep-92 "Black Wednesday": Britain, Italy and France suspend their membership of the narrow-band ERM

Feb-92 Following political agreement in Rome (11-12th December 1991), the Maastricht Treaty on Economic and Monetary Union is signed and ratified in all member countries during the rest of the year.

Jan-93 Stages One of the Convergence to EMU begins, leading through Stage Two to the choice of irrevocable parities and the 1998 Convergence Report, leading to the approval of 11 member countries for initial EMU membership.

Jan-99 EMU Stage Three launched: national currencies remain in circulation at their irrevocably fixed exchange rate against the euro - effectively, as non-rounded denominations of the same monetary unit.

Jan-01 Conversion of national currencies into Euro notes and coins.

PRODUCTIVITY SLOWDOWN AND RECOVERY

Source: The Kok Report (2004)

AVERAGE EU INCOME PER PERSON AS % OF THAT OF USA

Source: High Level Group (2004): Figure 1

Exchange Rate and Relative Prices

1w

hPeP

If world prices are stable

But the home economy experiences inflation

A fall in the exchange rate can act as a safety valve or “parachute” by restoring the price competitiveness of our goods

The real exchange rate compares our prices with prices abroad: “purchasing power parity” favours equilibrium in our foreign trade

REAL AND NOMINAL EXCHANGE RATES - ITALY

50

100

150

200

250

300

350

400

Source: AMECO Ch. 15 (accessed Dec. 05)

1995

=100

- ex

chan

ge ra

te a

gain

st E

U-1

4

Nominal Real

E(e)

ih

enow

)(

1)1()1(

dendofperiownowh eEieKiK

Exchange Rate, Relative Returns, and Volatility

If total expected returns are quickly equalised by arbitrage...

…expected depreciation will generate an immediate change in today’s interest rate and/or exchange rate: expected depreciation causes either an immediate monetary contraction or immediate depreciation

TRADE-OFFS IN THE INTERNATIONAL FINANCIAL ARCHITECTURE

Mon

etar

y and

Mac

roec

onom

ic So

vere

ignt

y

Stable Real Exchange Rate

Free Mobility of Capital

A,D

B

C’’, C

C’

A: the Gold Standard as an “anchor” to the price levelB: the Bretton Woods compromiseC: the German model, Mrs Thatcher’s monetarist experimentC’, C’’: the Keynesians’ Last Hurrah between autarchy and stagflationD: back to the anchor: EMU, currency boards, dollarisation...

Benefits

(1971)

EMU: Costs and BenefitsCo

sts

and

Bene

fits

of m

onet

ary

unio

n

Trade Integration

Costs

(2010)

Benefits

(2010)

Costs

(1971)

Source: Commission of the European Union (2003) Second Progress Report on Economic and Social Cohesion. Communication from the Commission, Brussels, Commission of the European Union: COMM (2003) 34 Final): Maps

Income Disparities and EU Widening

The Growth of Structural Funds, 1975-2006

5%

7%

9%

25%

37%

30%

35%

32%

39%

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

1975 1981 1987 1992 1998 2002 2002(enl.) 2006 2006(enl.)

Source: adapted from Allan (2003), p. 244

% o

f E

U B

ud

get

Delors I

Delors II

Berlin

Agreement

“GREED IS GOOD”

From Intermediation to Securitization

Source: Lane (2012) “The European Sovereign Debt Crisis”, p. 52.

The Single Capital Market at Work(lending to the private sector)

Source: Lane (2012) “The European Sovereign Debt Crisis”, p. 53.

The Single Capital Market at Work(external borrowing)

while Germany is running a big trade surplus with the rest of the eurozone which Germany's private sector is no longer willing to finance, transfers of one sort or another are inevitable. But no-one should be under any illusions about how difficult this is for politicians to explain to their electorates, even if they understand themselves. In the public's eyes and in the minds of many politicians, a trade surplus just shows that their country is more competitive. What could be wrong with that?

Simon Tilford, July 2012

The Single Capital Market Frozen

The Lender of Last Resort (LLR)

• Liquidity: money back today

• Solvency: money back in full

• The fire-sale problem

• “to lend freely on good security at a time of crisis” (Walter Bagehot, Lombard Street)

Eurozone Sovereign Debt Crisis: Greece

• Focus on ECB’s liquidity management 2007-9• October 2009 – Greek general election• Budget revises deficit from 6 to 12.7% of GDP• Earlier years’ budgets (and thus debt) also

revised up• Rising cost of servicing debt forces first Greek

bailout in May 2010

Eurozone’s Sovereign Debt Crisis:continued

• Ireland (November 2010)• Portugal (April 2011)• Greece again (March 2012)• Spain, Cyprus (June 2012)

European Financial Stability Facility

• Established in 2010 to avoid another “Greece I” bailout (Euro 110bn hard to cobble together)

• Hopes that it would merely deter bank runs by its existence

• Yet needed for Ireland and Portugal within months

• Euro 440bn not enough

European Stability Mechanism

The trouble with consolidation

• The “denominator effect” of low growth, low inflation limit the “natural” fall in debt-to-GDP ratios

• “Adjustment fatigue” leads to protests• “Financial repression” within the single market is

increasingly difficult – residents cannot be forced to buy government bonds

• Persistent, significant risk praemia raise the cost of servicing existing debt in the Eurozone’s periphery

The Banking Union Proposal

• A true banking union removes all national differences in the policy and regulatory environments in which banks operate

• Crisis Prevention– Regulation– Supervision

• Crisis management: LLR• Crisis resolution: bailing in/out

Adjustment I: price flexibility

Adjustment II: FDI – Perhaps, but...

Adjustment III: Migration – really?

“either poor countries will become richer, or poor people will move to rich countries. Actually, these two developments can be seen equivalent. Development is about people: either poor people have ways to become richer where they are now, or they can become rich by moving somewhere else. “ (Milanovic 2012)

Fiscal transfers? Not really (yet?)

we frown upon the transmission of family-acquired wealth to offsprings if two different individuals belong to the same nation [but] we take it as normal that there is a transmission of collectively acquired wealth over generations within the same nation, and if two individuals belong to two different nations, we do not even think, much less question, such acquired differences in wealth, income and global social position. (Milanovic 2012)

European policy-makers have been reluctant to accept that the eurozone's decentralised nature makes it an inherently unstable currency union that forces its constituent states and 'their' banks into a pernicious and deadly embrace.

On the face of it, all that changed at the June 29 summit, when member-states agreed to consider establishing a banking union. Among the features of such a union would be: a shared supervisory authority; a collective deposit protection scheme for the currency union; and a common resolution framework for dealing with weak banks.

... The idea of a banking union is sometimes spoken of as an easier route to 'mutualisation' (or federalisation) than issuing common debt – partly, the reasoning goes, because citizens do not understand what a banking union entails.

Philip Whyte, July 2012

CAN THE EU FACE THE TRUTH?