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Moneda, precios y el monetarismo en Europa

Aquí podéis encontrar la charla que tuve el placer de dar a mis amigos y colegas del Centro Hazlitt de la Universidad Francisco Marroquín (UFM), en Guatemala (Marzo 2020). El tema era la vigencia (o su no vigencia) del monetarismo como perspectiva y escuela de análisis económico en Europa. Como comprobaréis, soy muy pesimista en mi presentación; sobre todo en lo que se refiere a la explicación de la inflación en los modelos económicos predominantes en las ultimas tres/cuatro décadas. A pesar de ello, reivindico el uso de un análisis monetario riguroso (de la oferta y de la demand da dinero) si queremos explicar tendencias en los precios en el medio y largo plazo; una afirmación que me parece obvia, pero que en el entorno académico actual resulta tristemente revolucionaria … . Además, si bien soy muy crítico con el estado de los modelos macroeconómicos en lo que respecta a la explicación de la inflación, soy más optimista por lo que en la práctica los bancos centrales hacen cuando se enfrentan a una crisis financiera. Hemos visto cómo a partir de 2009/10 (o más tarde en la Eurozona), los bancos centrales recurrieron a operaciones de compra de activos (‘expansión cuantitativa’ o QE en sus siglas en inglés) para evitar la caída de la cantidad de dinero. Querían evitar con ello caer en el mismo error en el que cayó la Reserva Federal de los EEUU en los años 30 del siglo XX. Pareciera como si, por la vía de los hechos, los bancos centrales estuvieran persiguiendo una política monetaria encaminada a lograr la estabilidad del crecimiento del dinero (‘a la Friedman’).

Asimismo, también comento en algún detalle en la presentación algunas de las críticas más habituales que se hacen al monetarismo desde distintas perspectivas teóricas: como (1) la (supuesta) necesidad de imponer la estabilidad en la demanda de dinero (o de su inversa, la velocidad de circulación) para su validez en la práctica; o (2) el no tratamiento de los efectos reales que las variaciones en la cantidad de dinero traen consigo a medio y largo plazo. Como veréis en este video, intento demostrar que ambas críticas no son ciertas o están basadas en supuestos erróneos, y que la ecuación cuantitativa del dinero sigue siendo un esquema teórico válido para explicar variaciones de los precios y de la actividad nominal a lo largo del tiempo. Eso sí, no debería utilizarse esta ecuación y los supuestos en los que se basa, de una manera miope y mecanicista; eso sería un error grave. Hay muchas variables que afectan a la inflación en el corto plazo que están fuera del alcance de esta ecuación y de lo que los banqueros centrales pueden aspirar a controlar. Además, hay un grado indudable de incertidumbre y de retardos en la transmisión de las variaciones de la cantidad de dinero en los precios y la actividad económica; de ahí que sea mejor hacer análisis en el medio y largo plazo o en tendencia.

Aquí tenéis la grabación de la charla, que fue seguida de un coloquio con los miembros del Centro Hazlitt de la UFM que resultó muy provechoso e interesante. Muchas gracias a los asistentes y especialmente a Daniel Fernandez y a Clynton López, por su amable invitación a participar en estos seminarios. A ver cuándo podemos repetirlo!

Juan Castañeda

 

‘Devaluaciones competitivas y crecimiento económico’: Presentación en la Universidad Francisco Marroquín (UFM), Guatemala, en Marzo de 2020.

Podéis encontrar el video de la charla aquí:

De lo que hablo en esta charla es de (1) las consecuencias reales de las devaluaciones competitivas a medio y largo plazo y (2) de las diferencias entre una devaluación interna y externa. Utilizo ejemplos de las devaluaciones competitivas de la Peseta de los años 90 del siglo XX en España y de las llamadas ‘políticas de austeridad’ o de ‘devaluación interna’ practicadas durante la crisis de la Eurozona (approx. 2009 – 2013). Las primeras no condujeron a una mejora real de la competitividad de la economía española a medio y largo plazo, mientras que las segundas sí supusieron una bajada de costes y precios y, en última instancia, una mejora en la balanza por cuenta corriente española. También recurro al ejemplo de la economía británica bajo el patrón oro, cuando no eran posibles devaluaciones competitivas y la moneda mantuvo su poder de compra estable durante aproximadamente un siglo; lo que fue acompañado de un crecimiento significativo de la economía. Y, sí, como cada vez que puedo, utilizo las caricaturas clásicas de James Gillray para explicar el patrón oro. Además, (3) dedico los últimos minutos de la presentación a una reflexión sobre lo que la Economía enseña y cómo creo debería enseñarse, algunas de sus leyes fundamentales, así como a la actitud intelectual modesta y precavida que el economista debe adoptar a la hora de diseñar políticas.

Espero que disfruten de la presentación y la encuentren provechosa. Tengan en cuenta que está dirigida a alumnos cursando de estudios de Economía en educación secundaria. Como siempre, fue un placer visitar la UFM y colaborar con buenos amigos y colegas.

Juan E. Castañeda

 

 

On the economic effects of the policy responses to Covid-19

Today the Institute of Economic Affairs (IEA, London) has just published a report by my colleague Tim Congdon and myself (Institute of International Monetary Research and University of Buckingham) on the debate on the expected inflationary vs. deflationary consequences of the current crisis. Of course there are many unknowns yet and we should not claim or have the illusion that we can forecast exactly inflation rates in the next 2-3 years. But what we can attempt is to do ‘pattern predictions’ (see Hayek’s 1974 Nobel lecture speech). Based on the monetary data available and the theoretical body linking changes in the amount of money to price changes over the medium/long term, we have observed in the last two months an extraordinary increase in the amount of money in most leading economies (certainly in the USA, with a rate of growth of money, M3, of 25% in April 2020). This comes from the implementation of quite significant asset purchases programmes (i.e. Quantitative Easing) and the (partial) monetisation of very much enlarged government deficits; a trend that will most likely continue for the rest of the year. It is both the extraordinary money growth rates seen recently, along with the expected persistence in monetary growth in 2020 what support our forecast of an inflationary cycle in the US (and in other leading economies, though to a lesser extent) in the next 2-3 years. The diagram below from the report says it all (see page 8).
More details in the report (IEA Covid-19 Briefing 7, June 2020) at:
https://iea.org.uk/themencode-pdf-viewer-sc/?file=/wp-content/uploads/2020/06/Inflation_the-new-threat25787FINAL.pdf. Also, the webinar presentation of the report with my colleagues Geoffrey Wood and Tim Congdon will be available soon at the IEA’s website/YouTube channel.
Money growth (M£) in the USA
Juan Castañeda
Summary of the report (in pages 4-5):
  • The policy reaction to the Covid-19 pandemic will increase budget deficits massively in all the world’s leading countries. The deficits will to a significant extent be monetised, with heavy state borrowing from both national central banks and commercial banks.
  • The monetisation of budget deficits, combined with official support for emergency bank lending to cash-strained corporates, is leading – and will continue to lead for several months – to extremely high growth rates of the quantity of money.
  • The crisis has shown again that, under fiat monetary systems, the state can create as much as money as it wants. There is virtually no limit to money creation. The frequently alleged claim that ‘monetary policy is exhausted at low (if not zero) interest rates’ has no theoretical or empirical basis.
  • By mid- or late 2021 the pandemic should be under control, and a big bounce-back in financial markets, and in aggregate demand and output, is to be envisaged. The extremely high growth rates of money now being seen – often into the double digits at an annual percentage rate – will instigate an inflationary boom. The scale of the boom will be conditioned by the speed of money growth in the rest of 2020 and in early 2021. Money growth in the USA has reached the highest-ever levels in peacetime, suggesting that consumer inflation may move into double digits at some point in the next two or three years.
  • Central banks seem heedless of the inflation risks inherent in monetary financing of the much-enlarged government deficits. Following the so-called ‘New Keynesian Model’ consensus, their economists ignore changes in the quantity of money. Too many of these economists believe that monetary policy is defined exclusively by interest rates, with a narrow focus on the central bank policy rate, long-term interest rates and the yield curve. The quantity theory of money today provides – as it always has done – a theoretical framework which relates trends in money growth to changes in inflation and nominal GDP over the medium and long term. A condition for the return of inflation to current target levels is that the rate of money growth is reduced back towards annual rates of increase of about 6 per cent or less.

A model of parallel currencies under free exchange rates

Money is one of the most studied and truly complex phenomena in Economics. How money is created? And how is it destroyed? ‘What constitutes money and what doesn’t? Is money only the means of payment sanctioned by law, by the State? In our current monetary systems, can we ‘create’ as much as money as we like? If so, wouldn’t it be inflationary? These are some of the questions Economics students frequently ask at the start their degrees. Today I am only going to focus, if only timidly, on one of them; the absence of competition in the national currencies markets in our days. Of course, the absence of competition in this market is not the result of the application of the conventional laws of Economics; quite the opposite, as masterly explained by Vera Smith in her ‘Rationale of Central Banking and the Free Banking Alternative’ in 1936, the granting of the legal tender clause to a single currency, that issued by the State, has been an explicit decision made by the government (the relation between the State and the central bank has always been problematic to say the least, you can find more details on it here). F. Hayek also explains marvellously the abolishment of the laws of Economics as regards money in his ‘Denationalisation of Money’ in 1976. More recently, my colleague from the Institute of International Monetary Research (IIMR), Tim Congdon, discussed this issue in his ‘Money in a Free Society’ in 2009 and makes the case for a privatised and truly independent central bank, detached from the political agenda or the economic needs of the government.

Following this debate, two colleagues of mine, Pedro Schwartz and Sebastian Damrich, and myself have reflected on these issues in a working paper just published by the Applied Economics Centre of the John Hopkins University (‘A model of parallel currencies under free floating exchange rates’. In Studies in Applied Economics, Num. 160, June 2020). In the paper we assess the feasibility of a parallel currency system under different macroeconomic scenarios. We first offer the rationale for the introduction of more competition in this market and then develop a model to see wether (and under which conditions) a parallel currency system ends up in the running of a single currency economy, or rather in two currencies competing for the market. We draw policy implications and use the the eurozone as a case-study, but the model could well be applied to any other set of countries sharing a currency or willing to access a different currency area. In a nutshell, what we show in the model is the conditions for the issuer of each currency to gain a higher market share and benefit from it. We make a distinction between (1) a macroeconomic stable scenario, defined in the paper ‘as one in which the sensitivity of the market share of the currencies to changes in prices in both currencies is not high (as we presume changes in inflation in both currencies will be rather small)’ (see page 25). In this scenario, it is ultimately the supply of each currency what determines their market share (the less inflationary currency will gain more market share over time); and (2) a highly unstable macroeconomic scenario, ‘where agents’ demand of each currency is very sensitive to changes in relative prices in both currencies. In this high price sensitive scenario, an increase in the switching costs to favour the use of one of the currencies (i.e. the government’s preferred currency) would only lead to inflation in that favoured currency and very quickly to its expulsion from the market’ (see page 25). The model can thus be applied to well-established economies, where both the national currency and the common currency circulate in the economy and to highly inflationary economies, where the government favours the use of its currency and uses the currency as a source of revenues (i.e. seigniorage).

This is the abstract of the paper, which you will be able to access in full here:

‘The production of good money seems to be out of reach for most countries. The aim of this paper is to examine how a country can attain monetary stability by granting legal tender to two freely tradable currencies circulating in parallel. Then we examine how such a system of parallel currencies could be used for any Member State of the Eurozone, with both the euro and a national currency accepted as legal tender, which we argue is a desirable monetary arrangement particularly but not only in times of crisis. The necessary condition for this parallel system to function properly is confidence in the good behaviour of the monetary authorities in charge of each currency. A fully floating exchange rate between the two would keep the issuers of the new local currency in check. This bottom-up solution based on currency choice could also be applied
in countries aspiring to enter the Eurozone, instead of the top-down once and for all imposition of the euro as a single currency that has turned out to be very stringent and has shown institutional flaws during the recent Eurozone crisis of 2009 – 2013. Our scheme would have alleviated the plight of Greece and Cyprus. It could also ease the entry of the eight Member States still missing from the Eurozone.’

All comments welcome. We still have to work more on the paper and suggestions for change and further references will be most appreciated.

 

Juan E. Castañeda

PS. A previous study on parallel currencies by P. Schwartz, F. Cabrillo and myself can be found here; where we put it forward as a solution to ease and expedite the adjustments needed to apply to the Greek economy in the midst of the so-called euro crisis.

 

It’s not all about interest rates!

In a piece published by CityAM on 12/11/2019 (‘Interest rates aren’t central banks’ only ammunition to defend against recession‘), I criticised the view apparently shared by most policy commentators about the alleged lack of ammunition of central banks to tackle the next crisis; they claim that this is because policy rates have reached either zero or close to zero levels and therefore there is no more room for monetary expansion. As I put in the article, this is wrong:

But interest rate change is not the only policy tool available to create money. Indeed, nor is it the most effective in times of crisis. In modern economies, where monetary systems are purely based on fiat currencies, money can be created “out of thin air”. As shocking as it may sound, this means that central banks can always increase the amount of money in the economy.

Since 2008 central bank (main policy) rates had been cut down to zero or near zero territory, and for many years it was mainly by changes in the amount of money how central banks managed to stabilise spending (through unconventional policy measures or QE). The outcome in the US, the UK but also in the Eurozone (though achieved much later), has been the stabilisation of the rate of growth of broad money in these economies followed by a period of a relatively stable overall macroeconomic picture (i.e. broad money growth in the US around 4% – 5% for a long period of time).

 

Broad money growth, US

 

The fundamentals to understand how monetary policy decisions are made in modern monetary systems, particularly in times of a financial crisis, where commercial banks struggle to expand deposits, can be summarised as follows:

  • In the absence of a truly binding anchor (such a metallic standard under the gold or silver standards) central banks can always create money ‘out of thin air’, with no limit.
  • In modern monetary systems both commercial banks and central banks create money; actually the bulk of the means of payments used are created by commercial banks in the form of deposits and the extension of overdrafts (see the seminal paper on this, Money creation in the modern economy , by McLead, Radia and Thomas, 2014).
  • The announcement and later application of tighter bank regulation in the midst of the Global Financial Crisis (2009 – 2010) increased bank capital requirements by approx. 60%, thus limiting the ability of banks to give loans and create deposits (i.e. money) in an already recessive economy. In the absence of the creation of money by markets (i.e. banks), central banks had no choice but to step in and buy assets from the market (from non-financial institutions), the so-called QE operations. Otherwise, money supply would have contracted very severely, with the harm it would have inflicted on the economy (this time, central bankers were determined to avoid the mistakes they made in the Great Depression years as Ben Bernanke had famously put it back in 2002, when deposits contracted by more than 30% in four years in the USA, therefore aggravating and prolonging the recession).

I argue in the article that, for better or worse, the ‘monetary weaponry’ in modern monetary systems can never be exhausted (Venezuela today is a dramatic example of it, when the printing press is heavily exploited by the government). Under purely fiat monetary systems, we need to tie the hands of the central banks so they abide by a rule in order to maintain a moderate and stable rate of growth of money; a rule that does not result in excessive money growth during the expansion of the economy, nor in a strong decline or even a fall in money growth during recessions. My colleague from the University of Buckingham and the Institute of International Monetary Research, Professor Geoffrey Wood, explains masterly and in few minutes how to define and adopt such a monetary rule in the Eurozone in this video.

 

Juan Castañeda

PS. You can have access to the CityAM article in full at https://www.cityam.com/interest-rates-arent-central-banks-only-ammunition-to-defend-against-recession/

 

On the performance of the Euro vs. the US dollar (video presentation)

Those who follow this blog will know that I have already published an entry on the index of performance of the euro (1999 – 2018); I commented on the outcomes of an overall index of macroeconomic dispersion among the Eurozone Members States, which can be split up into four (sub) indices: business cycle, competitiveness, public finance and monetary dispersion. I have also reported on the same metrics calculated for the US, so we could compare then with those of the Eurozone. The results are somehow expected, but nevertheless very revealing.

  • Overall macroeconomic dispersion in the US is much smaller than in the Eurozone.
  • Macroeconomic asymmetries within the US states did exacerbate in the crisis years and also in the pre-crisis years, but in the US have quickly returned to pre-crisis levels and remained fairly stable since 2010; whereas in the Eurozone we still have a long way to go.

Of course, some caveats apply in this instance: the US dollar has been a single monetary area for more than 150 years, and indeed a banking union and a fiscal union (with a meaningful federal-central budget) for a long time too. Even with these caveats in mind, what it is very revealing is not that the size of macroeconomic dispersion or internal asymmetries are much larger in the Eurozone, but how differently macroeconomic dispersion has evolved after the crisis: In the case of the Eurozone, particularly as regards monetary and competitiveness dispersion trends, they  show a very strong persistence, revealing (among other things) a more rigid functioning of the price system in goods and services and labour markets as compared to those in the US. The caveats mentioned above may well explain the difference in levels of dispersions, but the changes in trends reveal underlying/structural problems in the way in which markets adjust to crisis in the Eurozone.

We are now extending the results of the project to include the index of dispersion among regions and nations within the UK sterling area, and the (provisional) results confirm the same pattern: the poorer performance of the Eurozone (as measured by internal dispersion) as compared to both the US dollar monetary area and the UK sterling one. We may disagree on the solutions to this problem but we should not simple ignore the facts. ‘All and sundry’ claim that a fiscal union and a pan-EU central budget should be adopted, so counter-cyclical policies can diminish the negative effects of ‘lateral shocks’ (those affecting some MSs considerably more than others) in the future. I do advocate for a different solution, one that requires no further integration, but the devolution of fiscal discipline to the national level. Here it is a the report with my proposal for the re-balancing of the Eurozone.

Here you will find the video to the presentation of the index of the Euro performance (2019) at the European Parliament, in an event organised by the Institute of International Monetary Research in Brussels (29/10/2019). Feedback most welcome.

Juan Castañeda

 

An optimality index of the single currency: internal asymmetries within the Eurozone and the USA since 1999

We have measured the macroeconomic dispersion within the Eurozone (see further details here on the indicators we have used) and this is in a nutshell how the euro (12 and 19) has performed since its launched in 1999.

 

As shown in the chart above we have added Target2 balances in the calculation of the (overall) index of internal dispersion; which is in fact an index of divergence within the Eurozone. The empirical conclusions are quite revealing, and somehow the expected ones: (1) in the good years (1999-2007), overall dispersion increased quite notably (it doubled!); (2) after the 2008-09 crisis, divergence deteriorated much more sharply and, leaving Target2 balances aside, the trend has been reversed and the index shows signs of improvement (though at a very slow pace).

We have also calculated an index of macroeconomic dispersion for the (mainland US) dollar area, using the same methodology. The chart below shows the trends in dispersion/internal asymmetries in this two major monetary areas:

 

There are many questions to discuss on this issue: among others, I will just mention three: (1) should we or should we not add Target2 balances to the calculation of the index of dispersion? (effectively, do Target2 balances matter?); (2) since the US is indeed a banking union, should we factor in monetary dispersion across States?; and (3) do the charts above suggest that the policies implemented during the recent crisis are the right ones in order to achieve a greater degree of convergence in the Eurozone?

We will discuss these questions and the charts above, and what they mean for the interpretation of convergence trends in the Eurozone, in a two-day conference at the University of Buckingham this week (21-22 February): The Economics of Monetary Unions. Past Experiences and the Eurozone. If you cannot make it, you will be able to follow the presentations live online. More information on the full programme here and how to follow it at the Institute of International Monetary Research social media.

All welcome.

 

Juan Castañeda

 

A proposal for Target2 reform and a capped mutualisation debt scheme in Europe

‘Under a monetary union, fiscal and monetary discipline have to go hand in hand if macroeconomic stability is to be maintained. The question is how to set up the right institutions to achieve this stability in a credible manner. This policy brief proposes a new institutional arrangement for the euro area to restore fiscal discipline. It places the responsibility for compliance entirely on the shoulders of the member states. It also provides for the mutualisation of 30% of the member states’ debt-to-GDP ratio.
This would help to maintain a stable currency and to limit the risk of contagion should another crisis occur in the future. However, this comes at a cost. Under the fiscal scheme proposed, member states, which would be fully fiscally sovereign, would need to run long-term sound fiscal policies to benefit from euro membership. In addition, this brief proposes a reform of Target2 under which overspending economies would have to pay the financial cost of accessing extra euros, which would deter the accumulation of internal imbalances within the euro area. All this is expected to change the current fragility of the architecture of the euro, provide member states with the right incentives to abide by sounder economic principles and make them fully responsible for the policies they adopt.’

The above is the abstract of a research report I have just written on the reforms needed to undertake to re-balance the eurozone economy, published by the Wilfried Martens Centre for European Studies. As you will read in the report, I don’t favour more centralisation of fiscal competences to the ‘federal’ level (be it Brussels or Frankfurt), but instead to abide by the subsidiarity principle as much as possible; and thus to make Member States (MSs) fully responsible for their own macroeconomic policies and public finances. The euro is a sort of a ‘monetary club’ (some will claim, and quite rightly, that it is much more than that) with benefits and costs of membership. As to the benefits, these are particularly evident for those economies with a poor inflation record in the running of their own national currencies in the past; for which the euro has provided a strong monetary anchor and therefore greater  price stability and lower borrowing costs. As to the costs, these were more subtle before the Eurozone crisis (and indeed less publicised at the time of the launch of the euro), and have become much more evident since then: simply put, MSs do not have access to their own (national) monetary policy anymore in order to ‘alleviate’ the costs of adjustment to a crisis, and also have limited sovereignty over their fiscal policy.

The reforms introduced during and after the recent crisis have confirmed the direction of change in the eurozone towards ever more co-ordination of macro policies; and therefore more and more conditions and criteria are now in place to closely monitor and eventually fine MSs for the running of (severe) fiscal and also macroeconomic imbalances (see the the new ‘Fiscal Compact’ and the new ‘Macroeconomic Imbalances Procedure’ for more details). If anything, the experience of how the excessive public deficits and public debt by different MSs were handled by the eurozone institutions before the crisis is not very promising; even less so now that the complexity and degree of macroeconomic integration and regulation are even greater. The approach I adopt in this report is quite different.

In a nutshell:

(1) I put forward a (capped) debt mutualisation scheme, so those MSs running sound fiscal policies and sustainable budgets can benefit from it; and those in excess of the annual debt threshold will have to issue their own bonds, backed only by their own national revenues and credibility. The scheme, once launched, is communicated to the MS and it is not negotiable; the scheme also decreases in the coverage of the MSs public debt for the current levels down to a 30% ratio of the GDP in ten years. With this scheme, the MSs will have the incentives to meet the pre-announced annual targets, as their debt will be covered under the debt mutualisation programme, and thus will benefit from much lower borrowing costs. And, crucially, there is no need to monitor nor regulate further the fiscal or macroeconomic performance of the MSs.

(2) I also propose a major reform of Target2, which has accumulated (particularly since 2008) enormous imbalances among MSs (see the latest balances across MSs at the ECB website here): On the one hand, Italy holds a debit position amounting to approx. 30% of its GDP while Spain’s is 25% of its GDP; on the other hand, Germany holds a credit position close for the value of nearly 30% of its GDP. The reform proposed in the report would consist of setting a price for access to credit (if only the ECB policy rate), so overspending economies find it more and more costly to keep on borrowing and thus accumulate further imbalances. A way to settle the existing balances cross MSs must be also addressed.

(3) There are other key elements in the report for the proposals above to be effective, such as the return to the ‘no bailout clause’ of MSs, and the possibility of an errant economy to leave the eurozone (or be temporarily suspended). More details in the report.

 

Juan Castañeda

Full text of the report at: https://www.martenscentre.eu/publications/rebalancing-euro-area-proposal-future-reform

Feedback most welcome.

 

 

In a fixed exchange rate system such as the euro symmetry in the application of the standard is key for the well running of the currency and even its preservation over the long term: i.e. surplus countries should overspend and run deficits (either private or public or a combination of both) so they suffer from an excess of money in the economy and thus ultimately higher inflation. And just the opposite in case of deficit countries within the euro standard, as they need to cut down their spending in order to cut costs and prices and ultimately regain competitiveness. This was for long considered, if only implicitly, as the main ‘rule of the game’ in the running of the classical gold standard at the time.

Of course we have heard about the application of adjustment policies in deficit countries in the eurozone during the recent crisis, the so-called ‘austerity policies’; or in the technical jargon, policies aimed at achieving ‘internal devaluation’ as an external devaluation is not possible at all. However, it is important to remember that it is the running of both policies in surplus and deficit countries what would lead to a balanced macroeconomic equilibrium over time in the eurozone. Just looking into the 2018 balances of each country (to be precise, each national central bank) in the Target2 payments settlement system in the Eurozone, we can see how far we are from symmetry in the area. Actually, the balances have been deteriorating quite dramatically since the summer of 2007; and now we have countries like Germany holding a significant creditor position against the rest of the Eurozone countries (and particularly against Italy and Spain) of nearly 30% of the German GDP.

 

Source: Institute of International Monetary Research, Monthly Update (2018). From ECB data. 

 

The gold standard is often taken as a predecessor of the euro standard; true, both systems are based on the commitment to fixed exchange rates but the euro standard is much more stringent and demanding in that it is amonetary union‘ (and not simply a ‘currency union‘ as the gold standard was, where national currencies ran at the announced fixed exchange rate and were ultimately governed by the national central banks). In an monetary union such as the euro standard the need to abide by symmetry, by both surplus and deficit member states, is even more difficult to articulate and achieve: the states do not longer have their national central banks to inject or withdraw money as needed be, and symmetry can mainly be achieved by expanding or tightening fiscal policy (and also by supply-side policies, that are indeed needed but take a longer time to be effective).

Along with two colleagues of mine, Alessandro Roselli (Cass Business School) and Simeng He (University of Buckingham) we have conducted a research on the measurement of asymmetry in the running of the gold standard from the 1870s to 1913. As shown in the table below, only the hegemonic economy, the UK, abided by symmetry, whilst the other 4 major European economies at the time did not (see table below).

See the following link for further details on our paper: https://www.researchgate.net/publication/328562649_A_measurement_of_asymmetry_in_the_running_of_the_classical_gold_standard

This is an extract from the paper with a summary of our conclusions, with striking parallels on the situation of the euro standard and the asymmetries mentioned above:

The consequences resulting from the running of the gold standard with a deficient degree of symmetry should not be underestimated, as countries like Germany and France refused to let the increase in reserves to be reflected in a greater amount of money supply. This created tension in the system, as countries like Italy or Spain would find it more difficult to regain competitiveness, and thus a greater internal devaluation was needed to be able to compete with their trade (surplus) partners.

Were the asymmetries of the pre-WW1 period the origin of the gold standard’s final collapse? The straight answer is negative: all the five countries here surveyed had to suspend the standard at the outbreak of the war, if not before such as Spain in 1883; it was the War, with the huge expansion of the money supply, dramatic inflation and social unrest that made later in the 1930s the gold standard unable to survive. In the post-war period, Britain had lost her hegemonic status and symmetry together with it.  (…) the asymmetry of the hegemonic country (the US) under the Bretton Woods System might well explain its collapse.

Should we infer from these experiences that symmetry of the hegemonic country is the precondition for a fixed rate system (or for a currency union with a single currency) to survive? And, referring to the Eurozone, should we think that Germany – unquestionably the hegemonic country – is behaving asymmetrically and that the Eurozone should collapse as a consequence? Another paper would be needed to answer these questions.

Some claim the Eurozone must be completed with a full fiscal (budget) union, so a meaningful ‘federal EU budget’ can transfer resources within the area when needed; however, even if politically feasible, this option will take time to take place and the imbalances within the Eurozone keep on accumulating day by day. There are pressing issues resulting from the lack of symmetry in the running of the euro standard no one can now deny: How are the Target2 balances going to be settled, if they will be at all at some point? Can persistent trade imbalances among member states run within Eurozone countries? Can more flexible goods and services as well as labour markets reduce asymmetries within the Eurozone enough? Can the Eurozone force surplus countries to be more expansionary when needed be?

The eurozone member states clearly opted for a more centralised monetary union during the crisis, and the questions above are some of the key questions still pending to address for the euro standard to stop accumulating internal asymmetries. The other option would have been to abide by the no bail-out clause stated in the Maastricht Treaty and the application of the subsidiarity principle in the construction of the eurozone, and thus let errant countries fail if they could not fulfil the strict requisites to remain in the eurozone; but this was clearly not the option taken.

 

Juan E. Castaneda

PS. For information, we will address these issues in a conference on ‘The Economics of Monetary Unions. Past Experiences and the Eurozone’ at the University of Buckingham (21-22 February 2019). Please check the speakers and the programme online should you want to attend (by invitation only).

How has the Euro performed? Are the economies of the Eurozone countries more homogeneous today than in 1999?

The 2017 optimality index 

Professor Pedro Schwartz and myself have conducted a research to (1) assess the trend in macroeconomic imbalances within the Eurozone since 1999 and (2) compare it to those in the US dollar monetary area. This is an extension of the research paper published last year in Economic Affairs (October, 2017), ‘How Functional is the Eurozone? An Index of European Economic Integration Through the Single Currency’. We have collected 10 different economic indicators per country (that is, for the 19 Eurozone Member States and 50 US states plus Washington DC) to measure how homogeneous or asymmetric the Eurozone Member States’ economies are, and calculated an overall index of economic dispersion, as well as four separate sub-indices to measure for asymmetries as regards (1) cycle synchronicity, (2) public finances, (3) competitiveness and (4) monetary and credit growth. The overall index can be interpreted as a measure of macroeconomic dispersion and thus of the asymmetries existing within the currency area.

In a nutshell, what the calculations and indices tell us is the following:

  1. Overall, the economies of the Eurozone Member States are less homogeneous today than in 1999. Integration did deteriorate even during the ‘good years’ (the expansionary phase of the cycle; specifically, a 86% accumulated increase in macroeconomic asymmetries from 1999 to 2006.
  2. During both the Global Financial Crisis and the Eurozone Crisis asymmetries escalated, in particular those regarding differences in competitiveness across Member States. Since 2015 the overall index of dispersion had shown a slight recovery: the new fiscal measures adopted at the EU level, along with the adjustment in costs and prices in those Member States mostly affected by the crises, seem to have been effective. In addition, the new programme of Quantitative Easing by the ECB, which began in 2015, has also helped, by reducing monetary growth dispersion across the Member States.
  3. However, this positive trend has been reversed in 2017, due to a deterioration in the competitiveness and monetary dispersion indices. This raises concerns about the stability of the Eurozone, since it shows that the return to macroeconomic stability and integration to something like pre-crisis levels is not an easy task even in times of economic growth. It also shows that the changes introduced in the euro architecture during the crisis have not been as effective as hoped.

For further details, you can access the summary of our project here: https://www.mv-pt.org/staff-research. You can also access the tables and figures with the comparison with the indices of dispersion in the USA here. These indices are now part of the research agenda of the Institute of International Monetary Research (IIMR) and an update with new figures will be published every year.

Note: Euro-12 and Euro-19 overall index of dispersion, 1999=100  (https://www.mv-pt.org/staff-research). The higher the value of the index the greater asymmetries are.

A full academic article by Pedro Schwartz and myself with further explanations on the figures and the calculations will follow soon. As always, comments most welcome!

Juan Castañeda