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Monetary Union in North America?

Monetary Union in North America?. Professor Ellen E. Meade Economics, American University. Introduction. Model of monetary union: European Monetary Union (1999) Costs & benefits of monetary union Theory of optimal currency areas Facts about NAMU Forms that NAMU could take

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Monetary Union in North America?

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  1. Monetary Unionin North America? Professor Ellen E. Meade Economics, American University

  2. Introduction • Model of monetary union: European Monetary Union (1999) • Costs & benefits of monetary union • Theory of optimal currency areas • Facts about NAMU • Forms that NAMU could take • Expanding the Federal Reserve System

  3. History of European Integration • Treaty of Rome (1957) created European Economic Community (EC) • Created customs union: abolished tariffs on trade among member countries, common external tariff on trade with outside countries • Beginning of integration • Beginning of supranational institutions

  4. Treaty on European Union • Known as Maastricht Treaty (1991) • Common foreign and security policy • Cooperation on justice and domestic affairs • Economic and monetary union • Known as EMU • Began in 1999 • Long process in 1990s to prepare

  5. EMU • In 1999, fixed bilateral nominal exchange rates between 11 countries • Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain • Greece joined in 2001 • Slovenia will join in 2007 • Single monetary policy set by European Central Bank (ECB) • Common currency “euro” introduced in 2002 • Exchanged national currencies from 1999 until euro

  6. Monetary Policy • ECB sets single monetary policy for entire euro area • Single short-term interest rate • Long-term interest rates can differ because reflect country characteristics • Maastricht Treaty gives it goal of price stability • Aims for annual consumer price inflation of 2 percent

  7. Organization of ECB • ECB Governing Council makes policy • 5 members of Executive Board who sit in Frankfurt • 12 presidents of national central banks • 17 votes cast at each meeting • Will change as euro area grows larger • Accountability • ECB is supranational • Testifies before European Parliament

  8. Other Issues • No consolidation of bank supervision and regulation • ECB is not lender of last resort • National fiscal policies remain • Effects on long-term interest rates • Stability and Growth Pact to restrain fiscal excesses

  9. Benefits of Monetary Union • Efficiency gains • Eliminate costs of currency conversion • Greater price transparency • No exchange rate risk • Trade effects (Rose 2000) • Financial market effects • Enhanced monetary credibility • Reduction in interest rates

  10. Costs of Monetary Union • Costs of switching • Must redenominate financial assets • Retail sector costs • Print and distribute new currency • Forego exchange rate adjustment and independent monetary policy • How important is this? • Optimal currency area theory

  11. Optimal Currency Area • Mundell (1961) • Asks when policy domain of monetary union can be right for member countries • Nominal exchange rate is price that adjusts when economic disturbances or shocks occur • Some shocks affect only one country • When fix exchange rate, how can countries adjust?

  12. Other Ways to Adjust • Wages and prices adjust • Must be flexible • Labor mobility • Immigration • Capital mobility (financial or physical) • No restrictions on capital flows • Diversity of economic structure • Must examine: shocks, wages, prices, immigration, capital flows, structure

  13. North American Monetary Union • Proposals for several forms of NAMU • Followed from: • 1990s financial crises in emerging markets (Mexico, Thailand, Korea, Indonesia, Malaysia, Russia) • Argentina’s discussion of dollarization • Four possible forms: • Amero (Grubel 1999), expanded Fed, treaty dollarization, unilateral dollarization

  14. ¹Merchandise trade as a percent of nominal GDP. Source: World Development Indicators (2006) and Direction of Trade Statistics (2006).

  15. Characteristics of NAMU • Lacks institutional infrastructure • NAFTA is free trade area, not customs union • No plan for institutions • Democratic accountability and legitimacy • No political will • Cannot imagine monetary union without political backing • Large asymmetry, US dominates

  16. NAMU Type (1) • Expanded Federal Reserve System • Two new district banks or re-draw lines of existing 12 banks • Canada is 7½ percent (Dallas or Richmond district) • Mexico is 5½ percent (Cleveland district) • Voting • Use US dollar • US dominates policy domain

  17. NAMU Type (2) • Treaty-based or cooperative dollarization • Canada and Mexico replace loonie and peso with US dollar • No say in setting monetary policy • Treaty governs distribution of seignorage • Some agreement on lender of last resort • US is policy domain

  18. NAMU Benefits & Costs • Very asymmetric • Economic benefits accrue mostly to Canada and Mexico • Cohen (2004) says little gain to US • Gains: eliminate conversions and XR risk, increase transparency • Gains: further trade and financial integration

  19. NAMU Benefits & Costs • Better monetary policy in Canada and Mexico? • Enhanced credibility reduces interest rates spreads • Bank of Canada and Bank of Mexico use inflation targeting cum floating exchange rate • Has delivered good results • How will adjustment occur without nominal exchange rate?

  20. Means of Adjustment • Wage and price flexibility • Labor mobility ?? • Nature of shocks • Composition of output: production of natural resources and oil • Do exchange rate changes smooth shocks to commodity prices? • Argument in Canada

  21. Concluding Remarks • Economic benefits for Canada and Mexico • Depends on view about adjustment to shocks • Political benefits from greater integration • Politics may be more important than economics • Immigration is important • NAMU under any form unlikely in near future

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