Better Off without the Euro? Evaluating Monetary Policy and Macroeconomic Performance for Denmark, Sweden and the U.K.

Stefan Krause, Emory University

The First Decade of European Monetary Union (May 28-30, 2008)

Motivation Over the past two decades,

macroeconomic performance has improved in both industrialized and developing countries.

Evidence suggests that Central Banks have played a decisive role in reducing both

the level and the variability of inflation have likely contributed (at least partially) to

smoothing business cycles as well

2The First Decade of European

Monetary Union

Figure 1a: Change in real GDP growth volatility(1991:I-1998:IV vs. 1999:I-2006:IV)

0.0 0.5 1.0 1.5 2.0 2.5

U.K.

SWE

DEN

U.K.

SWE

DEN

Standard Deviation (in %)

91-98

99-06H-P filtered series

Actual GDP growth data

3The First Decade of European

Monetary Union

Figure 1b: Change in CPI inflation volatility(1991:I-1998:IV vs. 1999:I-2006:IV)

0.0 0.5 1.0 1.5 2.0 2.5

U.K.

SWE

DEN

U.K.

SWE

DEN

Standard Deviation (in %)

91-98

99-06Subperiod inflation

Entire period inflation

4The First Decade of European

Monetary Union

Central Questions How much of the macroeconomic

performance gain experienced by Denmark, Sweden, and the U.K. is due to increased monetary policy efficiency?

Could further declines in macroeconomic volatility have been attained if these three countries would have adopted the Euro starting January 1999?

5The First Decade of European

Monetary Union

Outline of the Presentation

1. Measuring Monetary Policy Efficiency under independent policy (factual)

2. Macroeconomic Performance under the Euro (counter-factual)

3. Conclusions

6The First Decade of European

Monetary Union

Identification tool: Efficiency Frontier The efficiency frontier represents the

“best” a Central Bank can do

Better policy: Movements towards the frontier

Better luck: Frontier moves inward

7The First Decade of European

Monetary Union

Figure 2.1: Efficiency Frontiers and Performance Points(Denmark: Comparison across subperiods)

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8

Standard deviation of inflation (%)

Sta

nd

ard

de

via

tio

n o

f re

al g

row

th (

%)

91-98

99-06

91-98

99-06

8The First Decade of European

Monetary Union

Figure 2.2: Efficiency Frontier and Performance Point(Sweden: Comparison across subperiods)

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

0 0.5 1 1.5 2 2.5 3

Standard deviation of inflation (%)

Sta

nd

ard

de

viat

ion

of

rea

l g

row

th (

%)

91-98

99-06

91-9899-06

9The First Decade of European

Monetary Union

Figure 2.3: Efficiency Frontier and Performance Point(UK: Comparison across subperiods)

0

0.2

0.4

0.6

0.8

1

1.2

0 0.5 1 1.5 2 2.5

Standard deviation of inflation (%)

Sta

nd

ard

de

viat

ion

of

rea

l g

row

th (

%)

91-98

99-06

91-98

99-06

10The First Decade of European

Monetary Union

Results – Part I Comparing macro performance for

Denmark, Sweden and the U.K. between 91-98 and 99-06

Further performance improvement for all three countries ~25% performance improvement for Denmark

(about 80% due to policy) ~75% performance improvement for Sweden

(almost 100% due to policy) ~90% performance improvement for the U.K.

(about 90% due to policy)

11The First Decade of European

Monetary Union

Generating "alternate economies"

Recursive bootstrap technique

Iteration process to obtain 1,000 bootstrap samples of real GDP growth and inflation (alternate economies)

performance point under the Euro: average value (out of the 1,000 replications) of the pair of volatility measures

12The First Decade of European

Monetary Union

Figure 3.1: Efficiency Frontier and Performance Points(Denmark: Second subperiod)

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

0 0.1 0.2 0.3 0.4 0.5 0.6 0.7

Standard deviation of inflation (%)

Sta

nd

ard

de

viat

ion

of

rea

l g

row

th (

%)

Efficiency Frontier (99-06)

(under Euro)

(actual)

13The First Decade of European

Monetary Union

Figure 3.2: Efficiency Frontier and Performance Points(Sweden: Second subperiod)

0

0.2

0.4

0.6

0.8

1

1.2

1.4

0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8

Standard deviation of inflation (%)

Sta

nd

ard

de

viat

ion

of

rea

l g

row

th (

%)

Efficiency Frontier (99-06)

(under Euro)(actual)

14The First Decade of European

Monetary Union

Figure 3.3: Efficiency Frontier and Performance Points(UK: Second subperiod)

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

Standard deviation of inflation (%)

Sta

nd

ard

de

viat

ion

of

rea

l g

row

th (

%)

(under Euro)

(actual)

Efficiency Frontier (99-06)

15The First Decade of European

Monetary Union

Results – Part II Macroeconomic Performance under the

Euro 10-11% loss in macroeconomic performance

for Sweden 7-8% loss in the case of the U.K. for Denmark, relatively small performance

change; performance improvement from adopting the Euro depends on relative preference for inflation stability.

16The First Decade of European

Monetary Union

Conclusions Monetary policy played a sizeable role

in contributing to the reduction in inflation and real growth fluctuations, mostly for Sweden in the U.K.

None of the three countries would have experienced a larger macroeconomic performance gain if they had joined the EMU in 1999.

17The First Decade of European

Monetary Union

What’s next? Model specification? Examine with

alternative models

Higher frequency data

The U.K. is not a price taker – likely impact on the ECB rate

Your comments/suggestions

18The First Decade of European

Monetary Union