How has the euro performed as compared to the US$, 1999-2018?

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

 

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Index of internal asymmetries within the Eurozone

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

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The assessment of the eurozone: a measurement of its optimality (1999 – 2016)

‘How functional is the Eurozone? An index of European economic integration through the single currency’

This is the title of the paper I have just written with my good friend and colleague, Professor Pedro Schwartz (Camilo Jose Cela University in Madrid and University of Buckingham), which will be published in Economic Affairs (October issue, 2017).

We deal with a quite straight forward question: How can we measure the optimality of a currency area? When does it become more and more difficult to run a single monetary policy? If there are internal asymmetries in the currency area, how do they evolve? To answer, if only tentatively, these questions we have developed the method to calculate the index of optimality of a currency area, which we have split up in four major categories and components: (1) fiscal synchronicity, (2) public finance, (3) competitiveness and (4) monetary. Both the overall index and the above partial indices will inform us about the performance of the currency union and how internal asymmetries have increased or decreased. We have applied it to the eurozone, from 1999 to 2016. The results and calculations give us a metric to identify the building up of internal tensions in the running of the single monetary policy since the inception of the euro in 1999.

If only a chart, this is the summary of what we found in our research; in a nutshell, the adoption of the euro has not increased convergence among eurozone economies. The overall index of dispersion increased by 25% from 1999 to 2005 (see figure below),  and so asymmetries amongst member states even during an expansionary cycle. Of course, as expected, internal dispersion soared during and immediately after the outbreak of the Global Financial Crisis. This increase in dispersion in the crisis years ‘s not a symptom of the malfunction of the euro; what we should rather focus on is on the time taken for asymmetries to resume pre-crisis levels. Overall, even after 10 year since the start of the recent crisis, the optimality index still shows the Eurozone has a long way ahead to resume pre-2007 crisis levels (such as 1999 levels, when even countries joining the Eurozone were far from convergence).

 

 

This is the abstract of the paper:

‘This is a step in empirically assessing how near the Eurozone is to becoming an ‘optimal currency area’, as originally defined by Mundell (1961). For this purpose we have compiled ten indicators, organised them in four chapters, and summarised them in an overall indicator of ‘optimality’. The resulting picture is mixed, with zone optimality not increasing when circumstances were favourable but the trend towards integration returning after the 2008-2014 crisis. The suggestion is that dis-integration during the crisis, rather than an evidence of failure of the Eurozone when the going was tough, showed a self-healing mechanism at work. However our measurements and indices show that optimality is much lower than that in 1999.’

Feedback most welcome, as ever.

Juan Castañeda

 

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