Reden und Präsentationen

Es gilt das gesprochene Wort.

Ladies and Gentlemen, 


It is a great pleasure for me to be part of such a distinguished panel and to have the opportunity to present some of my reflections on the role of currency unions. The topic comes quite natural to a Euro system central banker and I am very proud that we have gone forward with the establishment of Economic and Monetary Union, which day after day proves that a currency union in Europe is not only possible but also successful. 


1. Introduction 

After the Asian (1997-98), the Russian (1998), the Brazilian (1998/99) and the Argentine (2001) crises the debate on the appropriate exchange rate regime has again intensified. Pegged exchange rates were often seen as a major cause of the respective crisis. Since then it has been popular to argue that a hollowing out of the middle of the exchange rate regime choice has occurred. This essentially means that only hard pegs, like currency boards, or independent floats are viable regimes among the continuum of exchange rate regimes. All the middle regimes such as soft pegs or managed floats are argued to be either unsustainable and/or too crisis-prone because they lack credibility and are vulnerable to speculative attacks. 
On the other hand in the recent literature on exchange rate regime choice, the concept of “fear of floating” (Calvo and Reinhart, 2002) has become popular. Fear of floating rests on the assumption that highly volatile exchange rates limit gains from trade, increase risk premia on interest rates and lower welfare. Exchange rate pegs and dollarization/euroization are frequently observed all over the world. But as we know, they involve high risks. 

In my presentation I will try to briefly review the sequencing of economic integration, highlight some aspects of the optimal currency area literature, look at the steps taken in Europe and will draw some conclusion for other regions in the world. The topic is broad and complex and thus this presentation will be parsimonious and only attempt to highlight certain important aspects. 


2. Steps of integration 

Monetary arrangements have a lot to do with the degree of economic integration. But there are no straightforward ‘laws’ about regional integration in the global political economy. Bela Balassa (1962) set out a logical roadmap. First countries decide to create a free trade area. This could then lead to a common external tariff, thereby producing a de facto  customs union. Efficiencies would be further generated by the formation of a genuine internal market amongst member countries. The gains of the internal market could be best achieved through further ‘deepening’ of integration. Therefore, monetary integration – the use of a common currency – would be the next stage. This in turn would generate incentives for further political integration. 

But how much political integration is required? This is still an open question. In my view at least some pooling of economic sovereignty seems to be necessary. This does not imply that a new political entity has to be formed. And whether all forms of integration such as customs unions, common markets and monetary unions must have similar levels of institutionalization remains an open question as well. 


3. Optimal Currency Areas 

The classical theory of Optimum Currency Areas (OCA) developed by Mundell, McKinnon and Kenen, defines an optimum currency area as a geographical region in which member countries should use absolutely fixed exchange rates or have a common currency. Whether countries belong to an optimal currency depends mainly on the symmetry of external shocks, the degree of labor mobility, the degree of openness and the extent of economic diversification. 

The idea behind the optimum currency area criteria is well known. If a region does not meet the OCA criteria, in the case of an external shock real adjustment takes a long time and is costly. In this case, a flexible exchange rate facilitates adaptation and minimizes costs. 

More recent literature (e.g. Frankel 1999) discusses another benefit of flexible exchange rates stressing the “impossible trinity”, i.e. the impossibility of having a fixed exchange rate, capital mobility and monetary independence at the same time. In the presence of high capital mobility flexible exchange rates allow policy makers to conduct an independent monetary policy for domestic purposes. If, however, domestic policy makers cannot make good use of the independence of monetary policy – and there is some empirical evidence that has been true for EMCs and developing countries in the past – it may be better to give up independence in order to import stability from other countries. 

Exogeneity or endogeneity of OCA criteria has also been in debate. Frankel and Rose (1998) argued that some criteria such as the synchronization of business cycles or trade relationships are endogenous. If this is true, an exchange rate peg and a common monetary policy can be self-validating such that countries joining the currency union will move closer to meet the OCA criteria by increasing intra-industry trade and correlating business cycles more closely. 

Nevertheless, OCA criteria seem to matter if a country decides to tie its currency to an unsuitable anchor. Argentina , for example, choosing a currency board with a non-dominant currency as an anchor proved disastrous when trade links are weak and business cycles are out of step with the anchor leading to increased debt, lower investment and lower growth (Hausmann et. al., 2002). Endogeneity did not work out its magic although one has to stress that Argentina ’s crisis was also the result of serious domestic shortcomings. 


4. European experiences 

European Economic and Monetary Union (EMU) has proved so far as a credible and successful remedy to an enduring European problem – namely, how to create a single internal market for capital, goods and services among member-states with highly interdependent economies in a world with multiple currencies, volatile capital flows, and fragile exchange-rate regimes. 

The decisions to complete the internal market in Europe in 1992 (Single European Act) as well as the decision in 1988 to remove all exchange controls made Europe more vulnerable to speculative attacks. The expected increased volatility of exchange rates was a serious threat to the internal market. The creation of Monetary Union and the European Central Bank was supposed to enable members to resolve the tensions and step down further on the road of integration. 

4.1 Net benefits of a currency union 

The Maastricht Treaty of 1991 specified the conditions, EU member states had to fulfill in order to be eligible for joining Economic and Monetary Union (EMU). The requirements included the well-known macroeconomic convergence criteria and institutional requirements such as central bank independence. 

These preconditions acted as a screening and commitment device such that governments showed their willingness to follow economic policies that did not impose costs on other members. The experience of the ERM I showed that the path towards a common currency is fraught with difficulties. ERM I painfully made clear that the internal adaptability of some economies participating was insufficient and not credible for a smooth working of the peg. The periodic crises and the recurring need for realignments within the ERM demonstrate that transition arrangements towards a currency union are only sustainable when economic policies are largely subordinated to the maintenance of the agreed exchange rate bands. The fact that the EMU countries were able to attain that goal is testimony to their strong political commitment to it. 

4.2 Costs, Benefits and Long-Run Sustainability 

As already mentioned, the elimination of transaction costs and exchange rate uncertainty can increase economic growth by reducing the real interest rate and by stimulating the international division of labor. This has been shown by several empirical studies: Faruquee (2003) pointed out that EMU has increased trade among members by 10% since 1999. He also showed that dynamic effects have been rising over time and are still increasing although these gains are not evenly distributed. Gains in trade are not necessarily guaranteed: structural policies such as ease of sectoral reallocation and market entry help to realize full potential from monetary union. Overall, Frankel and Rose (2000) concluded that a one percent increase in trade between countries of a currency union leads to an increase of per capita income of 1/3 of a percent. 

An important issue for the long-run sustainability of a monetary union are fiscal rules (Hochreiter et al. 2003; Christl 2003). Because fiscal policies remain decentralized, fiscal rules are based on political economy considerations and are intended to restrict the deficit bias of national governments. Public expenditure often is financed by debt issuance owing to inter-temporal redistribution considerations, thereby shifting the fiscal burden from today to the future. Fiscal rules also matter because monetary union membership can give rise to moral hazard and free-rider problems: Moral hazard because a member country is expected to be bailed out by others when faced with unsustainable debt levels; free-riding because fiscal laxity in one country can drive up the union-wide interest rate and can induce others to relax fiscal rules. 

Excessive deficits complicate monetary policy due to demand effects on prices. This also entails significant medium- and long-run costs such as higher real interest rates and tax burdens. Besides, political pressure could be exerted upon the central bank to monetize government liabilities if the monetary authorities of a currency union are not sufficiently independent. 

Since financial markets do not believe the no-bail-out clause and, interest rate spreads are only a minor punishment for excessive deficits, fiscal rules are a necessary condition for a credible and successful monetary union. In this context I would like to stress that the ongoing discussion in Europe on the Stability and Growth Pact is not at all helpful in this respect. 

4.3 Lessons so far 

I think the experience with monetary integration in Europe suggests the following: 

• Monetary union is contingent upon a high economic integration and upon strong political commitment; 
• But – as has also been pointed out by Professor Bordo – political union is not at all a requirement ex ante; 
• Outside factors such as systemic shocks and globalization seem to speed up the pooling of sovereignty in the economic domain. 
• Convergence criteria are necessary and act as a screening and commitment device to guide expectations. 
• To remain fully credible, a currency union requires policy coordination especially in the fiscal field coupled with an applicable enforcement mechanism as well as a forward-looking multilateral surveillance system. 
  
  

• In Asia and in Latin America defining a homogenous region is ambiguous, regionalism is pluralistic and overlapping but lacking a single dominant organization that supplies continental regional integration which was instrumental in case of the EU. MERCOSUR and ASEAN are at the best a first step in the context of the Balassa-sequencing. 
• Levels of nominal and real convergence in Asia as well as in Latin America are more heterogeneous than in Europe . And, therefore, the benefits of monetary integration would be lower and the costs associated would be higher in both continents. 
• In Asia at present the ‘natural’ leadership role of one of the big countries like China , Japan , and to a certain extent India is not yet clearly visible. In Latin America, Brazil at first inspection appears to be the dominant country but is not yet a regional stability hegemon.