theorie und politik der europäischen integration prof. dr. herbert brücker lecture 11 a monetary...
TRANSCRIPT
Theorie und Politik der Europäischen Integration
Prof. Dr. Herbert Brücker
Lecture 11
A Monetary History of Europe and the Choice of Exchange Rate Systems
Theory and Politics of Eropean Integration
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Last Lecture
• EU Competition and State Aid Policy· Economics of anticompetitive behaviour and state aid policy
– Collusion in the BECOMP framework– Horizontal anti-competitive practices
» cartels (e.g. the ‘Vitamin’-cartel) » abuse of domninant position (e.g. Microsoft)
– Merger control– State aid in the BECOMP diagram
· EU competition policy– EC competencies and EU law (Treaty of Rome)– Merger control
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
This lecture
• A monetary history of Europe• Metallic money• The gold standard• The interwar period• The post-war period: from Bretton Woods to the EMU
• Choice of an exchange rate regime• Exchange rate and monetary policy• The range of exchange rate policies• Choices
· Criteria· Fix or float?· Regional arrangements
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Why studying history?
• Monetary union is the controversial end of a long process. History helps understand.
• Since paper money was invented, Europe’s monetary history has been agitated. Each bad episode carries important lessons.
• Before paper money, Europe was a de facto monetary union. Understand how it worked helps understand how the new union works.
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Metallic Money
• Under metallic money (overlooking the difference between gold and silver) the whole world was really a monetary union
• Seignorage as key source of public finance -> ‘shaving’
• Multiplicity of money• Previous explicit unions only agreed on the
metal content of coins to simplify everyday trading
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Metallic money (cont.)
• From immemorial until 19th century metallic money (gold or silver)
• Monetary unions as a tool of nation-building• Germany: before 1871 different monetary standards
• Bimetallism (gold and silver) with fluctuating exchange rates depending on discoveries
• Two historical monetary unions• Latin Monetary Union (BE, FR, IT) to preserve bimetallism• Scandinavian Monetary Union ceased WWI
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Gold standard
• Classic gold standard period 1880-1914• Frequent financial crises, armed conficts and
depressions• Working of the gold standard: Hume’s “price-
specie-mechanism”• (“specie” = money/gold)
• Key assumptions• long-run neutrality of money• effect of money on interest rates
• Helps to understand working of EMU
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Neutrality of money and current account equilbrium
gold money
price level
P0
M1 M0
A
current account deficit
current account surplus
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Neutrality of money and current account equilbrium
gold money
price level
P0
M1 M0
A
current account deficit
current account surplus
Money determines the price level (in the long run)
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Neutrality of money and current account equilbrium
gold money
price level
P0
M1 M0
A
current account deficit
current account surplus
The price level affects the trade balance
• If domestic prices are
high relative to foreign
prices, we have a deficit
• Conversely, relatively low domestic prices lead to a trade surplus
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Neutrality of money and current account equilbrium
gold money
price level
P0
M1 M0
A
current account deficit
current account surplus
• Trade balance is achieved when the stock of money is M1
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Balance of payment equilbrium
gold money
price level
0M0
A
C
B‘
B
outflow of moneyinflow of money
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Balance of payment equilbrium
gold money
price level
0M0
A
C
B‘
B
outflow of moneyinflow of money
Hume’s mechanism: return to balance is automatic. If we start with deficit • (point A, high money stock M0), money flows out until we get back to balance
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Financial account equilbrium
gold money
interest rate
i*
M2M0
A
financial account surplusfinancial account deficit
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Financial account equilbrium
gold money
interest rate
i*
M2M0
A
financial account surplusfinancial account deficit
•Much the same story applies to the financial account: •if the domestic interest rate is high (low), •capital flows in (out) and the return to balance is automatic
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Monetary equilbrium under gold standard
• Money in excess of M0 translates into external deficits and gold outflows
• If money is in short supply (left of A = M0), balance of payments is in surplus and gold flows in
• Point A may correspond to a point with imbalances in current and capital account, e.g. current account deficit and capital account surplus in our example
• Financial markets support equilibrium: if money supply delines, interest rate increases, which attracts capital
• Over time, money sluppy stringency creates growth slow-down, higher unemployment, downward pressure on prices and wages
• All markets contribute to eliminate external imbalance, no need for government intervention (in theory)
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Rules of the game and problems
• Full gold convertibility at fixed price of all banknotes• Full backing. Central Bank holds same amount of gold as
notes issued• Complete freedom of trade and capital mobility
• Problems:• Sticky prices and wages (short-term disequilbria)• World money supply driven by discoveries and money
demand driven by economic growth go not hand in hand• Governments facing deficits tend to opt out of gold
standard
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Similarities to the EMU
• EURO replaces gold (no national money supply)• Balance of payments surplus translates into EURO
inflows• Balance of payments deficit translates into EURO
outflows• Exchange rate cannot be used to equilibrate
external deficits• Adjustment has to work via prices and wages
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
The interwar period: the worst of all worlds
• Paper money starts circulating widely• Yet the authorities attempt to carry on with the
gold standard but:• No agreement on how to set exchange rates between
paper monies• An imbalanced starting point with war legacies
· High inflation· High public debts
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
The interwar period: three case studies
The British case: a refusal to devalue an overvalued currency breeds economic decline
The French case: devaluation, undervaluation and beggar-thy-neighbour policies, until others retaliate and the currency becomes overvalued
• The German case: hyperinflation, devaluation and, finally, evading the choice of an appropriate exchange rate by resorting to ever-widening non-market controls
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Lessons so far
We need a system, one way or another
• The gold standard – monetary unions – delivers automatic return to equilibrium, but at the cost of booms and recessions
• No agreement leads to misalignments, competitive devaluations and trade wars
• Agreements require “rules of the game”, including a conductor
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
European postwar arrangements
An overriding desire for exchange rate stability• Initially provided by the Bretton Woods system• The US dollar as anchor and the IMF as conductor
• Once Bretton Woods collapsed, the Europeans were left on their own• The timid Snake arrangement• The European Monetary System• The monetary union
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
European postwar arrangements (cont.)
The Bretton Wood collapse• Financing the Vietnam war• Diverging inflation rates and real appreciation pressures• The realignment 1971• The collapse 1973
• The Snake arrangement• Agreeing on stabilizing intra-European bilateral parities• No enforcement mechanism: too fragile to survive
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
The EMS: Super Snake
Complements bilateral exchange rate commitments with a support mechanism
• Allows for prompt realignments to avoid misalignments
• Emergence of the DM as the system’s anchor
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Lessons from history
Goldstandard
Inter-war
BrettonWoods
EMS EMU
Long-lasting alignment must be avoided
Yes Yes Yes
Systems must be built coherently
Yes Yes Yes Yes
Policy misbehaviour must be ruled out
Yes
Systems must be robust Yes Yes
Needs a conductor Yes Yes Yes Yes
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
The choice of an exchange rate regime
An question and the answer
• The question: what to do with the exchange rates• Viewpoint of an individual country, in contrast with
Chapter 10 which looks at systems• Underlines the principles to evaluate the merits of a
monetary union
• The answer: there is no best arrangement• A matter of trade-offs
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Three basic principles
1 Long term: neutrality of money
2 Short term non-neutrality of money
3 Interest parity condition
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
The long-term neutrality of money: theory
A
B
C
ADADlong-term AS short-term AS
output gap
Inflationrate
0
The AS-AD model output gap (Actual – Trend GDP)
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Long term neutrality implication: PPP
• The real exchange rate• Defined as = EP/P*• PPP: E offsets changes in P/P*• So is constant
• Many caveats, though
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Short term non-neutrality of money
• From AD-AS: the short-run AS schedule• So monetary policy matters in the short run• Channels of monetary policy
• The interest rate channel• The credit channel• The stock market channel• The exchange rate channel
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Monetary policy in the IS-LM model
A
CB
D
IS
IS‘
LM LM‘
Output-gap(Actual-Trend GDP)
Foreignlevel
Fixed exchange rate: no independent monetary policy
Money is endogenous
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Fiscal policy in the IS-LM model
A
B
C
IS
IS‘
LM LM‘
Output-gap(Actual-Trend GDP)
Foreignlevel
Flexible exchange rate: no effect of fiscal policy
The exchange rate offets fiscal policy effects
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Exchange rate regimes and policy effectiveness
Monetary policy
Fiscal policy
Fixed exchange rate
Ineffective Effective
Flexible exchange rate
Effective Ineffective
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
When does the regime matter?
• In the short run, changes in E are mirrored in changes in = EP/P*: P and P* are sticky
• In the long run, is independent of E: P adjusts• If P is fully flexible, the long run comes about
immediately and the nominal exchange rate does not affect the real economy
• Put differently, the choice of an exchange rate regime has mostly short-run effects because prices are sticky
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
What’s on the menu?
• Free floating• Managed floating• Target zones• Crawling pegs• Fixed and adjustable• Currency boards• Dollarization/Euroization• Monetary union
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
The choice of an exchange rate regime
• The monetary policy instrument• Can be useful to deal with cyclical disturbances• Can be misused (inflation)
• The fiscal policy instrument• Can also deal with cycles but is often politicized• Can be misused (public debts, political cycles)
• Exchange rate stability• Freely floating exchange rates move “too much” • Fixed exchange rates eventually become misaligned
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
The old debate: fixed vs. float
• The case for flexible rates• With sticky prices, need exchange rate flexibility to deal
with shocks• Remove the exchange rate from politicization• Monetary policy is too useful to be jettisoned
• The case for fixed rates• Flexible rates move too much (financial markets are often
hectic)• Exchange rate volatility: a source of uncertainty• A way of disciplining monetary policy• In presence of shocks, always possible to realign
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
The new debate: the two-corners solution
• Only pure floats or hard pegs are robust• Intermediate arrangements (soft pegs) invite government
manipulations, over or under valuations and speculative attacks
• Pure floats remove the exchange rate from the policy domain
• Hard pegs are unassailable (well, until Argentina’s currency board collapsed…)
• In line with theory• Soft pegs are half-hearted monetary policy commitments,
so they ultimately fail
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
The two-corners solution and the real world
• Fear of floating• Many countries officially float but in fact
intervene quite a bit• Fear of fixing
• Many countries declare a peg but let the exchange rate move out of official bounds
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Fear of floating
80.00
90.00
100.00
110.00
120.00
130.00
140.00
1999M1 1999M7 2000M1 2000M7 2001M1 2001M7 2002M1 2002M7 2003M1 2003M7
Denmark (vis a vis €)Sweden (vis a vis €)Switzerland (vis a vis €)Korea (vis a vis $)
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
The two-corners solution and the real world
• Fear of floating is deeply ingrained in many
European countries
• Fear of fixing partly explains the disenchantment
with the EMS and some reluctance towards
monetary union
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Conclusions
• A menu hard to pick from: trade-offs are everywhere
• All of this takes the view from a single country• Systems involve many countries and rest on agreed
upon rules, including mutual support• Since the end of Bretton Woods, there is no world
monetary system• This leaves room for regional monetary systems.
Enters Europe’s experience
Theory and Politics of European Integration Integration of Labour Markets
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
NEXT LECTURE
• Optimum Currency Areas• Reading: Baldwin/Wyplosz (2006, Ch. 16)