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The simple evidence shows the decline of the periphery countries and the progress in the core until the onset of the financial crisis. A diverse monetary union is a rigid construction that has benefits and costs for both sets of countries. In difficult times, it prevents devaluation in weak countries. In a context of wage and social benefit rigidity, this will lead to unemployment and high public deficits.
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In a sharp downturn, only some form of cross-country transfer or implicit guarantee will avoid a sovereign default which would inevitably imply the end of the monetary union. Alternatively, political pressure for relief in weak countries may well force a breakup of a monetary straightjacket. The notion that stronger countries gained a boost to their international competitive position while weak countries had to endure a higher and more rigid exchange rate offers a legitimate foundation for cross-country support in crisis periods.
Weak countries would previously restore balance by a competitive devaluation either deliberate or induced by capital flight. As in such periods, capital flows tend to target safe havens, countries with higher financial credibility would experience dramatic revaluation, as in the case of the Swiss franc. Our institutional interpretation of a diverse monetary union is close to the content of the public debate, and identifies effects not captured by a traditional economic analysis.
At times of distress, it is a natural temptation for national politicians to blame other countries. It is the job of economists to explain the general equilibrium benefits of a monetary union. A diverse monetary union has several redistributive effects, but offers its greatest benefit to production and employment in strong countries, with the indirect effect of constraining the competitiveness of producers in weaker member countries.
A natural channel to alleviate tension while redistributing the burden and gains from a diverse monetary union would be direct transfers. General expansionary policies are less effective as a large part may be spilled over to the rest of the world. Fiscal transfers are invisible within a single country, but politically sensitive between countries. This is particularly true since individuals from strong countries will tend to self-attribute their relative success, while citizens of weak countries will blame their reluctance to support.
To be clear, frustration with past fiscal laxitude is justified. Yet it fails to appreciate that some burden sharing compensates for the implicit monetary support provided by weak economies renouncing the adjustment allowed by devaluation. Paradoxically, the competitive gain by strong countries increases in the diversity of monetary union members.
The German productive gain is proportional to fiscal laxity elsewhere. The monetary union has complex redistributive effects. It supports producers in strong countries and savers in weak countries. It imposes a short-term cost on savers in strong countries, though it promotes the value of productive investment and thus wealth creation. The biggest loser is the tradeable sector in weak economies.
Accordingly, it is unfair to blame weak employment in these countries on a poor work attitude. In the absence of fiscal rebalancing, the burden of alleviating the redistributive tension shifts to monetary policy. A relaxed stance offers indirect relief to weak countries, but is poorly targeted. While it counterbalances the very tight monetary conditions imposed by the monetary union on weak countries, it exacerbates expansionary conditions in strong countries, currently struggling with rising house prices and mortgage credit expansion.
Initially the ECB was limited to lending to banks on favourable terms. Yet as a central bank cannot assume risks, its lending requires good collateral, which is by definition scarce in weak countries. More targeted measures included a modest programme of purchases of targeted assets the path historically chosen by the Fed until , and cross-country fiscal guarantees that strengthened the safety of sovereign debt.
Monetary union | economics | leondumoulin.nl
With the exception of Greek debt, no losses have been incurred in this coordinated relief policy. The recent ECB quantitative easing programme has returned to purchases of sovereign debt according to its capital key, a counterproductive decision made for political reasons. Its untargeted approach has various redistributive effects. Next to the stated impact on savers and producers, now core countries experience monetary conditions that are too loose.
In order to limit spillover effects, quantitative monetary policy should target the monetary rigidity suffered by weak countries via an asymmetric purchase programme. Given the clear moral hazard consequences, quite explicit in our institutional analysis, the policy should be tied to a real transfer of spending review authority to the Eurozone countries. We have outlined the redistributive effects created by the rigid structure of a monetary union next to its direct effects on monetary credibility. We highlighted the general equilibrium benefits that core countries draw from it and the cost paid by the productive sector in weaker countries.
Going forward, maintaining the euro requires a fairer and long-sighted ECB policy that targets sovereign or private bonds from weaker economies, in conjunction with a grand fiscal bargain that would centralise authority over Eurozone public budgets and pension policy decisions. Resisting this reality risks the catastrophe of a breakup. The end of the Eurozone would cause weak country citizens to lose a large part of their savings, while strong country citizens would suffer from an extreme revaluation and a much shrunken foreign market.
Admittedly, old savers in these countries may have an immediate benefit from revaluation, but hardly anyone else would benefit. In any case, a sharp revaluation would ultimately undermine pension funding as well. A superficial reading of the problem by populists leads to demands that weak countries shape up their national institutions. But all research on economic underdevelopment has shown how institutions are very persistent and cannot easily be reformed internally.
Monetary union
Institutional change takes generations, not years. While markets adjust quickly in terms of trade, credit pricing, or quantity , local institutions do not. This is another way to state the key mistake at the start of the euro monetary union: As a result, political opportunism went unchecked. Yet currently most benefits of the monetary union flow to its core. Both distortions are economically and politically unsustainable. Europe faces a clear challenge.
The success of the transition to the banking union suggests that a collective effort at institutional evolution can succeed. An asymmetric monetary policy should be combined with centralisation of fiscal authority, assigning stronger and more direct powers of spending review to the EU while stopping well short of fiscal unification. Rebalancing policy choices that alleviate the monetary stricture at the periphery needs to also constrain future spending, or they would be inacceptable and even counterproductive. The discipline on weak national institutions then fully legitimises some amount of burden sharing.
The main obstacle to a serene choice on this matter is a poor recognition of the nature of deep institutional differences. While spontaneous institutional convergence is to be expected as a result if the EU, it would take a long time. Recognising legitimate needs and necessary changes may move us beyond destructive populist pressure driven by incomprehension of the bigger picture. While this may hardly seem the time for institutional reform, there has never been a better time.
There remains the question of whether the south would ever voluntarily adopt northern prudence.
Casella , Person and Tabellini EU institutions EU policies Europe's nations and regions. EMU , institutional quality , monetary union , redistribution , eurozone. The conduct of monetary policy in a diverse monetary union Enrico Perotti 04 April The members of the Eurozone are diverse in terms of their institutional quality.
Aftershocks of monetary unification: Hysteresis with a financial twist. The inception of EMU involves a number of stages. In stage two , individual national currencies were replaced by a new single currency - the euro see EURO entry for further details. Advocates of EMU argue that a common currency will create a more stable economic environment as distortions such as the exchange-rate cost and risks associated with the conversion of national currencies will be removed. Also, a common currency will have the advantage of enhancing price transparency so that price differentials for the same product as between EU countries will tend to disappear and prices will tend to be driven down to the level of the most efficient supply source.
A particular problem facing the EU is that of chronic unemployment, which can be effectively tackled only, as some economists argue, by supply-side policies aimed at improving labour market flexibility rather than monetary measures alone.
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Economic and Monetary Union A group of independent countries with a common market , no trade barriers between members, and a single currency. That is, in addition to the single currency, there are no tariffs on goods and services and citizens of participating countries may live and work in other countries with no restrictions. An economic and monetary union may be considered, for many but not all economic purposes, a single country.
Political union and some autonomy in each country with respect to economic policy are the only aspects that keep an economic and monetary union from complete economic integration. References in periodicals archive? In a joint letter to the representatives of the EU institutions and Member States, the issues discussed in the context of the completion of the EU Economic and Monetary Union are relevant to all EU countries, therefore, not only the euro area countries must be involved in the debate on this issue.
The letter from the Finance Ministers is addressing the strengthening of the EU economic and monetary union. Political leaders should therefore adopt economic policies and institutional reforms that are broad-based and far-sighted in order to build a stronger economic and monetary union in Europe. A better EMU blueprint: The aim of economic policy coordination was to attain lasting economic convergence among the member states and to maintain this following the start of Stage Three of economic and monetary union.
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