Barry Eichengreen

Exchange market mayhem: the antecedents and aftermath of speculative attacks

Exchange market mayhem The antecedents and aftermath of speculative attacks This paper evaluates the causes and consequences of episodes of turbulence in foreign exchange markets. Using data from 1959 through 1993 for twenty OECD countries, we consider the antecedents and aftermath of devaluations and revaluations, flotations, fixings and speculative attacks (which may not be successful). We find that realignments of fixed exchange rates are alike: devaluations are preceded by political instability, budget and current account deficits, and fast growth of money and prices. Revaluations are mirror images of devaluations. Speculative attacks resemble devaluations, but money growth and inflation are more endemic and there is no last-minute attempt to tighten monetary policy. In contrast, few consistent correlations link regime transitions like flotations or fixings to macroeconomic or political variables. Transitions between exchange rate regimes are largely idiosyncratic, and are neither consistently provoked ex ante by systematic imbalances, nor typically justified ex post by subsequent changes in policy. We conclude that there are no clear early warning signals of many speculative attacks, and no easy solutions for policy-makers. — Barry Eichengreen, Andrew K. Rose and Charles Wyplosz

Adjustment and growth in the European Monetary Union: Shocking aspects of European monetary integration

Introduction From all appearances the process of European monetary unification continues to gather momentum. Nearly four years have passed since the last significant realignment of exchange rates of members within the European monetary system (EMS). All significant controls on capital movements among member countries have been removed. Discussions of the establishment of a European central bank and a single currency are proceeding apace. If the current timetable is observed the transition will have been completed by the end of the decade. At the same time there remain serious questions about the advisability of a European Monetary Union (EMU) voiced, in the most recent round of discussions, by the governments of the United Kingdom and Spain. By definition, EMU involves a sacrifice of monetary autonomy. In response to country-specific shocks, governments will no longer have the option of adopting a monetary policy which differs from that of the union as a whole. Insofar as monetary policy is useful for facilitating adjustment to disturbances, adjustment problems may grow more persistent and difficult to resolve. These concerns are reinforced to the extent that it is believed that completion of the internal market will place new limits on the use of fiscal policy. Not only will individual governments have lost autonomy over the use of seigniorage to finance budget deficits but, insofar as the 1992 process renders factors of production increasingly mobile, constraints will be placed on their ability to impose tax rates significantly different from those of their neighbours.

The Unstable EMS

FROM THE STANDPOINT OF EUROPEAN MONETARY AFFAIRS, 1992 opened with a bang and closed with a whimper. In January, the European monetary system (EMS) celebrated five years of exchange rate stability: sixty full months without a realignment. The month before, the representatives of European Community (EC) member-states initialed the Treaty on Economic and Monetary Union concluded at Maastricht in the Netherlands. The transition to European monetary union (EMU) appeared to be fully underway. By the end of the year, the European monetary system had enduredindeed, was continuing to experience-the most severe crisis in its fourteen-year history. Two of ten currencies, the Italian lira and the British

The Stability Pact: more than a minor nuisance?

Stability Pact More than a minor nuisance? The Stability and Growth Pact will lead member countries to aim for cyclically balanced budgets. Until this steady state is reached, Europe will continue its efforts at de.cit cutting. While so doing, politicians are less likely to undertake the dif.cult labour market reforms that are really needed. Is further .scal retrenchment wise? The paper reviews the reasons that have been advanced in favour of a Stability Pact and .nds them wanting. The most serious justi.cations, such as the systemic risk of bank crisis following a government.s failure to service its debt, can be better dealt with in other ways: for example, by prudential limits on banks. exposure to public debts. Moreover, our analysis reveals that the macroeconomic costs of the Stability Pact, while sizeable, are not as dangerous as often believed. The costs will be barely visible once the steady state is reached. The true macroeconomic costs are front loaded; they concern the next few years, after a decade already dominated by convergence efforts. — Barry Eichengreen and Charles Wyplosz

Ever Closer to Heaven? An Optimum-Currency-Area Index for European Countries

In this paper we develop a procedure for applying the core implications of the theory of optimum currency areas to cross-country data. We demonstrate that these implications find strong empirical support. The relationship between the characteristics of countries to which OCA theory points and the observed behavior of exchange rates seems sufficiently stable and robust to support simple forecasting. Extrapolating the independent variables, we therefore use our exchange rate equations to predict which countries will be best able to support stable exchange rates in the future -- equivalently, which are likely to be best prepared to be among the founding members of Europes monetary union.

Is Europe an Optimum Currency Area

An optimum currency area is an economic unit composed of regions affected symmetrically by disturbances and between which labor and other factors of production flow freely. The symmetrical nature of disturbances and the high degree of factor mobility make it optimal to forsake nominal exchange rate changes as an instrument of adjustment and to reap the reduction in transactions costs associated with a common currency. This paper assesses labor mobility and the incidence of shocks in Europe by comparing them with comparable measures for Canada and the United States. Real exchange rates, a standard measure of the extent of assymetrical disturbances, remain considerably more variable in Europe than within the united states. Real securities prices, a measure of the incentive to reallocate productive capital across regions, appear considerably more variable between Paris and Dusseldorf than between Toronto and Montreal. A variety of measures suggests that labor mobility and the speed of labor market adjustment remain lower in Europe than in the United states. Thus, Europe remains further than the currency unions of North America from the ideal of an optimum currency area.

Trade blocs, currency blocs and the reorientation of world trade in the 1930s

We analyze the impact of commercial and financial policies on the reorientation of trade in the 1930s. We report evidence that commercial policies attenuated prior connections between income growth and trade, and that exchange rate instability marginally discouraged international trade. In contrast, the tendency toward regionalization commonly ascribed to the formation of trade and currency blocs was already evident to a considerable extent prior to the regional policy initiatives of the 1930s. This reorientation is more properly attributed to ongoing historical forces such as commercial and financial links between countries forged over many years.

DEMOCRACY AND GLOBALIZATION

The relationship between democracy and globalization has been a subject of both scholarly and policy debate. Some argue that the two go hand in hand – that unrestricted international transactions encourage political accountability and transparency and that politically free societies are least likely to restrict the mobility of goods and services. But others argue that democracies, in which special interests that suffer from foreign competition have voice, are more likely to have closed markets, and vice versa. Our analysis differs from its predecessors in three ways. We seek to uncover general patterns by considering as long a period as possible and all countries with the relevant data. We consider multiple dimensions of globalization, analyzing both trade liberalization and capital account liberalization. And we estimate these relationships using an instrumental variables strategy that allows us to confront the issue of simultaneity. Our findings support the existence of positive relationships between democracy and globalization.

When Does Capital Account Liberalization Help More than it Hurts

In this paper we reconsider the evidence on capital account liberalization and growth. While we find indications of a positive association, the effects vary with time, with how capital account liberalization is measured, and with how the relationship is estimated. The evidence that the effects of capital account liberalization are stronger in high-income countries is similarly fragile. There is some evidence that the positive growth effects of liberalization are stronger in countries with strong institutions, as measured by standard indicators of the rule of law, but only weak evidence that the benefits grow with a countrys financial depth and development. We find more evidence of a correlation between capital account liberalization and growth when we allow the effect to vary with other dimensions of openness. There are two interpretations of this finding, one in terms of the sequencing of trade and financial liberalization, the other in terms of the need to eliminate major macroeconomic imbalances before opening the capital account. By and large our results support the second interpretation.

Exit Strategies : Policy Options for Countries Seeking Exchange Rate Flexibility

In a world of increasing capital mobility and broadening and more diversified trade, many (but not all) developing and transition economies are likely to find it desirable to move from relatively fixed exchange rate regimes to regimes of greater exchange rate flexibility. This paper suggests why, and considers strategies that countries may consider for such a move. It reinforces this discussion with a review of experience from teh past two decades with alternative exchange rate regimes. The paper also identifies policies that can facilitate the transition to greater exchange rate flexibility for countries that wish to pursue this option.