Monetary Integration By: Jia Ling Royce Yu Econ-515 Spring 2005
Monetary Integration • What is MI ? • the transition from multiple currencies to one currency. • coordination of monetary policies of multi-currencies for monetary stability. • Why nations need MI? • to avoid vulnerability and instability of multiple currencies.
How to Do MI • Surrender’s approach • dolarization (market). • Government mandate • unification(shock therapy). • Partner’s approach • agreements(institutional approach).
Theory about MI(1) • Fixed exchange rate system • gold standard, US dollar system. • Flexible exchange rate system • pegged, band, crawling. • Floating rate • market driven.
Theory about MI(2) • Optimum Currency Areas • rooted in Keynesian tradition. • assumptions: price level and wage level of an economy are rigid. • besides flexible rate: alternative? How effective compared with flexible rate? • three criterions to exam: • the degree of factor mobility. • the degree of openness. • the degree of coordination of fiscal policies.
Theory about MI (3) • OCA: • In areas where exist symmetric incidence of shocks and real wage rate flexibility as well as mobility of labor, an optimum currency area can be formed so as to gain better efficiency of transaction and welfare benefit than an exchange rate flexibility can offer (Mundell, 1961).
Theory about MI (4) • The father of the Theory of OCAs: • Professor Robert Mundell. • 1999 Nobel Laureate. • He initiated it in 1961.
Theory about MI (5) • Self_Validating OCA (two equilibria identified) • in the first equilibrium local pricing; foreign price determined by the Law of One Price. Optimal policy rules then target the domestic output gap and floating exchange rates support the flex-price allocation. • in the second equilibrium local pricing; a monetary union is the optimal policy choice for all countries. • Benefit:Although business cycles more synchronized with a common currency, flexible exchange rates are superior in terms of welfare.
Past efforts of MI • 1979-1999 from US dollar system to MI • An exercise of political economy. • Three alternative ways: • market approach (Panama). • institutional approach (EU). • a shock therapy (Germany,1989-1990).
Present issues • Policies tied to low-inflation target (2.8%). • Policies constrained by the pursuit of a balanced-budget. • Cost of time consuming coordinations and complex procedures. • Uneven political and economic commitment: balancing for growth and gain.
Future Issues • Expansion • drive neighboring countries to feel pressured to join in. • to counteract divergences: labor mobility. • Deeper integration: financial market and political coordination. • The journey has just started.
Pros • Lowers transaction costs • Reduce uncertainties • Ends currency instability in the participating countries • Lowers interest rates
Cons • Loss of some macro policy independence. • Loss of some national sovereignty • Introduction cost • Loss of some seigniorage
Requirements Based on Maastricht Treaty in Dec.1991