Transcript Economics of Monetary Union 10e

Type De
Paul
author
Grauwe
names here
Economics of Monetary Union 10e
Chapter 3: The Benefits of a
Common Currency
© Oxford University Press, 2014. All rights reserved.
Introduction
• The costs of EMU have mostly to do with
macroeconomic management
• The benefits are mostly microeconomic in
nature,
– i.e. they arise from efficiency gains of a monetary
union
De Grauwe: Economics of Monetary Union 10e
Sources of benefits
•
•
•
•
•
Less transaction costs
Price transparency
Less uncertainty
Benefits of an international currency
Does monetary union lead to more economic
growth?
De Grauwe: Economics of Monetary Union 10e
Less transactions cost
• Elimination of foreign exchange markets within
union eliminates cost of exchanging one
currency into another
• Cost reductions amount to 0.25 to 0.5% of GDP
(according to European Commission)
• Full cost reduction only achieved when
payments systems are fully integrated
– TARGET payment system
– Single Euro Payments Area (SEPA):January 2008
the launch of the SEPA Credit Transfer (STC)
– November 2009: customers of banks are able to
make transfers across countries in the same way as
they do within countries.
De Grauwe: Economics of Monetary Union 10e
Price transparency
• One common unit of account facilitates price
comparisons
• Consumers “shop around” more
• Competition increases
• Prices decline and consumers gain
De Grauwe: Economics of Monetary Union 10e
Does euro increase price
transparency in a significant way?
• Large price differentials continue to exist
• These have to do with
– transactions costs at the retail level
– and product differentiation
• See next figure
De Grauwe: Economics of Monetary Union 10e
Large price differentials of identical products in
eurozone (2005)
Figure 3.1 Price index per country versus Eurozone in 2005
Figure shows average
price of a basket of
160 identical brand
name products in the
Eurozone countries.
Price index per country versus Eurozone
Germany
Netherlands
Spain
Italy
Belgium
Average price is
expressed as an
index relative to the
Eurozone average.
France
Eurozone
Austria
Greece
Portugal
Finland
85
90
95
100
105
Source: ACNielsen(2005)
De Grauwe: Economics of Monetary Union 10e
110
115
120
Eurozone has not increased
price convergence
Figure 3.2 Evolution of price dispersion in the Eurozone, 1990– 2005
0,45
•Euro has not changed
this
• There is no evidence
of price convergence
•Euro may work
indirectly by triggering
further market
integration in
particular sectors, e.g.
banking, insurance
mean standard deviation
0,4
0,35
0,3
0,25
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Source:Wolszczak-Derlacz (2006)
De Grauwe: Economics of Monetary Union 10e
Less exchange risk
• Euro eliminates exchange risk. Two issues:
– Does the decline in exchange risk increase welfare?
– Does the decline in exchange risk reduce systemic
risk?
De Grauwe: Economics of Monetary Union 10e
Less exchange risk and welfare
Figure 3.3 Profits of the firm under price certainty and uncertainty
Price certainty
Price uncertainty
P
P
MC
F
MC
E
P3
P1
G
P2
q
De Grauwe: Economics of Monetary Union 10e
B
P1
C
q
• Profits are higher on average when there is price
uncertainty
• Welfare will then depend on degree of risk
aversion
• If risk aversion sufficiently high price certainty is
preferred by firms
• Model has a number of important assumptions
– No adjustment costs
– With sufficiently large price declines firm can go
bankrupt; model assumes no bankruptcy costs
De Grauwe: Economics of Monetary Union 10e
• Exchange rate changes are not normally
distributed
• There are often very large and sustained
changes
• Which are the result of bubbles and crashes
• Examples:
De Grauwe: Economics of Monetary Union 10e
Two bubbles and two crashes
Figure 3.4 Bubbles and crashes in foreign exchange markets: two examples.
Euro-dollar rate 1995-2004
DEM-USD 1980-87
1,3
3.3
1,2
1,1
2.8
1
2.3
0,9
0,8
1.8
0,7
1.3
1987
1986
1985
1984
1983
1982
1981
1980
De Grauwe: Economics of Monetary Union 10e
0,6
6/03/95
6/03/96
6/03/97
6/03/98
6/03/99
6/03/00
6/03/01
6/03/02
6/03/03
6/03/04
• Large exchange rate movements are a recurrent problem
with freely floating exchange rates.
• They create large adjustment costs.
• They occurred massively during the early 1990s within EU
when some currencies (e.g. the Italian Lira and the
Spanish peseta) depreciated by 20 to 30% creating large
adjustment costs in countries like Germany and the
Benelux.
• These large exchange rate movements between the
currencies of highly integrated countries became sources
of asymmetric shocks
• …and convinced many leaders of EU countries to move
into a monetary union.
De Grauwe: Economics of Monetary Union 10e
Monetary Union and
economic growth
Figure 3.5: Neo-classical growth model
y
r
f(k)
A
r
k
De Grauwe: Economics of Monetary Union 10e
Potential growth effects
of monetary union
MU eliminates exchange
risk and may reduce
systemic risk. If so, real
interest rate declines
Figure 3.6 The effect of lower risk in the neoclassical
growth model
y
r
B
r’
A
r
r’
f(k)
rr-line becomes flatter (r’r’)
Economy moves from A to
B
Per capita income
increases because of
capital accumulation
Economic growth
increases during transition
from A to B
k
De Grauwe: Economics of Monetary Union 10e
Endogenous growth and monetary union
Figure 3.7 Endogenous growth in the ‘new’ growth model
y
C
B
A
f’(k)
f(k)
Capital accumulation
can lead to dynamic
effects leading to
technological
innovations.
Production function f(k)
then shifts outwards
raising economic growth
k
De Grauwe: Economics of Monetary Union 10e
How much of this growth promise
has come through?
Figure 3.8: Average real growth of GDP in a number of
countries
Not much.
This confirms that in
the long run money
and monetary
institutions do not
matter for real
things such as
economic growth.
Source:: OECD Dataset--Economics Outlook.
De Grauwe: Economics of Monetary Union 10e
Why has monetary union not boosted
growth?
• Main reason: reduced exchange rate
uncertainty within the union did not lead to a
significant decline on the real interest rate in the
eurozone as a whole.
• Only in the “catching up” countries like Ireland,
Spain, Portugal, and Greece did the real
interest rate come down significantly.
• It is in these countries (with the exception of
Portugal) that we observe an acceleration of
economic growth as predicted by the theory.
De Grauwe: Economics of Monetary Union 10e
• The reduction in exchange rate uncertainty
does not necessarily reduce the systemic
risk.
• Less exchange rate uncertainty may be
compensated by greater uncertainty
elsewhere, e.g. output and employment
uncertainty.
• As a result, firms that operate in a greater
monetary zone may not on average operate
in a less risky environment.
De Grauwe: Economics of Monetary Union 10e
Empirical evidence about monetary
union and trade
• First generation empirical studies found little
relation between exchange rate volatility and
trade
• Using cross-section evidence Andy Rose
recently found strong effect of monetary union
on trade:
– a monetary union doubles trade among members of
union, on average.
– More recent econometric evidence has reduced
these effects to 10%-20%
De Grauwe: Economics of Monetary Union 10e
Benefits of an
international currency: seigniorage
• International use of the dollar creates
seigniorage gains for the US
• Similarly, if euro becomes an international
currency, seigniorage gains will follow for
Euroland
• These gains, however, remain relatively small:
– in the case of the US: less than 0.5% of GDP per year
De Grauwe: Economics of Monetary Union 10e
Benefits of an international currency:
easy government finance
• US profits most from international role of dollars
• Foreign central banks (e.g. China) hold a few
trillion dollars as reserves
• Thereby allowing for easier finance of US
government deficits
• This can also lead to moral hazard
De Grauwe: Economics of Monetary Union 10e
Benefits of monetary union
and openness
Figure 3.11 Benefits of a monetary union and openness
of the country
Benefits
(% of GDP)
Benefits of monetary union
are likely to be larger for
relatively open economies
In absence of monetary
union, transaction costs and
exchange risk are larger for
firms in very open economies
Monetary union will be more
beneficial for firms in very
open economies
Upward sloping benefit line
Trade (% of GDP)
De Grauwe: Economics of Monetary Union 10e
Fixing exchange rate
and systemic risks
Figure 3.9 Shocks in the IS curve
r
LM
Shocks in IS-curve:
monetary union increases
variability of output
F
rf
ISU
IS
ISL
yL
y’L
y’U
yU
De Grauwe: Economics of Monetary Union 10e
y
Figure 3.10 Shocks in the LM curve
LML
r
LM
LMU
Monetary union
reduces variability of
output
G
rf
ISU
IS
ISL
yL
y
yU
De Grauwe: Economics of Monetary Union 10e
Shocks in LM-curve
y