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European monetary integration? A review essay
Journal of Monetary Economics 18 (1986) 329-336. North-Holland
EUROPEAN
MONETARY INTEGRATION? A Review Essay Geoffrey E. WOOD*
The Ci!v
Uniuersip.
London
EC2 Y 8HB.
England
1. Introduction There have been several proposals for the creation of a European Monetary System. In his recent book - The European Monetary System: Past, Present and Future (Martinus Nijhoff Publishers, Amsterdam, 1984) - Peter Coffey considers these existing European monetary plans, and makes some suggestions of his own to further monetary integration in Europe. The book is in eight parts, comprising fifteen chapters plus a section headed ‘Conclusions’. The subjects covered are a survey of the historical background, a description of the system, various considerations - technical, capital market, and institutional - relevant to its future, and discussion of interactions between EMS member countries and others. In appraising both this book and the prospects for monetary integration in Europe, it should be borne in mind that pressure for European monetary integration has largely been produced from political motives. It has been urged by advocates of political union in Europe, who saw it as a further step towards their goal of a ‘United States of Europe’. Discussion has been of how to achieve monetary integration rather than of whether it is desirable. Indeed, and no doubt in some cases deliberately, it has been left obscure what advocates of European monetary integration mean by monetary integration. It is therefore useful first to set out some basic analytical points. 2. The meaning of monetary integration Monetary integration must mean that there is complete freedom for both current and capital account transactions within the integrated area. There must be no exchange controls or any equivalent restrictions. These conditions could of course be satisfied under freely floating exchange rates, the extreme of *I am indebted to Dr. A.B. Balbach. Professor M.D. Bordo, Dr. F.H. Capie, Professor H. Grossman, Professor L. Pressnell and Dr. Anna J. Schwartz for their comments on a preliminary version of this review. 0304-3923/86/$3.5001986.
Elsevier Science Publishers B.V. (North-Holland)
330
G. E. Wood.
European
monetary
integration?
monetary independence. Accordingly, then, monetary integration must comprise in addition an exchange rate union - the fixing of exchange rates against each other within the integrated area and a common arrangement towards currencies not in the union. Such an exchange rate union can be either a ‘pseudo union’ or a ‘complete union’. (To use the terms coined by Max Corden in 1972.) The first is an agreement to fix exchange rates, the agreement perhaps being accompanied by promises of economic policy coordination; the second involves pooling of foreign exchange reserves, establishment of a central bank for the monetary union, and the issue of a common currency for the union. The first is a Bretton Woods type system. Under Bretton Woods, surplus and deficit countries eventually changed their exchange rates rather than continue to inflate or deflate. As a result of that experience countries which formed a pseudo-union would be expected to behave that way now, so that there would be a flood of funds across the exchanges whenever a country seemed under pressure to change policy. That flood would then precipitate the exchange rate change. Indeed, it has been the experience of the European Monetary System (EMS) to date that countries have changed exchange rates fairly readily. Policy has not been subordinated to irrevocable pegging of the exchange rate. Suppose, however, that there were the political will in Europe to create a complete European Monetary Union. Would its creation be desirable? 3. Arguments for monetary union A large part of discussion of this issue has been in the setting of a stable, non-vertical, long-run Phillips curve. For example Corden (1973) saw as a major problem for European Monetary Union that countries would be forced away from their preferred inflation/unemployment combinations. Some countries would, he feared, become permanently depressed areas as a result of being forced to choose lower rates of inflation than they would without the fixed exchange rate constraint.’ With that difficulty removed as a result of both theoretical developments and the experience of the 197Os* the way seems clear to monetary union. That does not, however, mean a union should be formed. Feasibility is not optimality. There is a small body of literature on the choice of optimal domain for a currency. The main contributions are Ingram (1959,1962), Mundell (1961), McKinnon (1963), and Corden (1972,1973). ‘That countries might experience permanent high unemployment as a result of a fixed exchange rate was also feared by some ministers (notably Ernest Bevin) in the war-time British government. This led to the so-called ‘Catto Clause’ being negotiated at the Atlantic City pre-Bretton Woods meeting in late June and early July 1944. This clause ensured ultimate national sovereignty over exchange rate changes. (Lord Catto was Governor of the Bank of England.) ‘As noted by Corden (1980, ch. 10).
G. E. Wood,
European
monetary
integration?
331
Mundell, writing implicitly within the Phillips curve framework, argued that the optimum currency area is the area of factor mobility - so long as factors, particularly labour, are mobile, there will be no need for exchange rate changes to change real wages and hence the unemployment rate. McKinnon made an opposing point - if a region were very open, so that a large part of what was used was tradable, then exchange rate changes might not change real wages. Indeed, perhaps not very likely except under conditions of high inflation and incipient currency collapse but certainly a possibility, wage bargains might not be struck in terms of domestic currency. Corden’s contribution was threefold. He developed the concept of a feasible currency area, and refined both McKinnon’s and Ingram’s arguments. A feasible area is one which can have its own currency, and the associated possibility of exchange rate changes. It is not so involved in trade with some other country that it simply uses that other country’s currency. McKinnon’s argument was essentially one for choice of currency domain on grounds of what would yield the greatest stability of the price level. When should one want fixed rates to impart price level stability? The answer depends not only on the openness of the economy, as McKinnon conjectured, but also on the source of the disturbance. If the disturbance is a change in the foreign price level, then domestic price stability requires an exchange rate change. Only if disturbances are domestic is the effect of a fixed exchange rate stabilising, via stabilising the price of traded goods. Ingram argued from the experience of Puerto Rico that a pegged exchange rate encouraged capital mobility, and this prevented the emergence of the depressed areas which Corden (and others) feared. The argument is straightforward. There is a decline in demand for the principal export of some area. Workers become unemployed. On seeing this, capital (free of exchange risk) flows in, and the workers become employed in a new industry. However, if the workers became unemployed because they had pushed up wages there would be no incentive for capital to flow in; capital mobility would not remove this difficulty. As Corden observed in his interchange (1973) with Ingram, the source of the disturbance is crucial, just as it is in McKinnon’s argument. Those few points summarise the theory of optimum currency areas, so far as it goes. It is clear that what the theory comprises is not a framework within which a proposal for a monetary union can be rigorously appraised, but rather a set of points to be considered in the course of discussing such a proposed union. 4. Any advance? How does Peter Coffey’s book advance our understanding of either the theory of monetary union, as sketched above, or of the application of it to appraising the desirability and prospects of European monetary integration? The answer is, not at all. Peter Coffey asserts (p. 2) that ‘. . . theoretical
332
G. E. Wood.
Europeart
nlotletaty
integration?
considerations have, at all times, been in the author’s mind’. They may have been in his mind, but they are seldom brought into use. In the preface (p. 2) he describes an optimum currency area as a set of countries having a ‘similar propensity to inflate’. What is a propensity to inflate? Is it a fundamental behavioural characteristic, like a propensity to save? We are not told. Suppose it just means inflation rate. Then if countries do have similar inflation rates, the major cause of exchange rate pressure is certainly removed. These countries could probably keep their exchange rates pegged. But that says nothing about whether it is optimal to do so. The first four chapters comprise a brief history of plans for European monetary integration, and description of its present institutional character. Chapter 5 moves on towards appraisal of the performance so far of the EMS. There are few problems with these chapters although the appraisal chapter is rather thin. Exchange rate variability within the EMS was indeed lower than among the EMS currencies before the introduction of the system. But the environment was different and there was a cost in terms of increased wnpredictable variability in other variables [see Wood (1983)]. Coffey does not mention these factors. There is an abundance of non-sequiturs: ‘. . . the ECU (European Currency Unit - roughly speaking, an average of EMS member currencies) is the third most important currency/reserve asset for the European Investment Bank and for Italy. Internationally it is among the top three currencies’ (what does that mean?) ‘and reserve assets. Therefore (emphasis added) the author proposes that all the Community Member States should agree to allow their citizens to hold private bank accounts in ECUs’ (p. 39). There is absolutely nothing wrong with the recommendation - it enlarges freedom of choice. But it certainly does not follow from the statements which precede it. It would be possible to continue for page after page in this vein, but it would serve little purpose. It is, however, essential to deal with certain proposals and comments which are certainly misleading and in some cases potentially harmful. Peter Coffey is strongly in favour of intervention in and control over financial markets by monetary authorities. Indeed, he favours the creation of what he rather quaintly terms a ‘central organ’ for this purpose. ‘. . . the need for a greater Community control over the ECU markets will grow. In turn, this underlies the need for a real European Monetary Fund.. . ’ (p. 40). Why do these markets need controlling? Coffey argues from the history of the Euro-dollar market. ‘Preferably, the, situation of the Euro-dollar market, with all the implications of lack of community control - should not be allowed to be repeated in the ECU Bond market’ (p. 38). What is puzzling is why the major implication of lack of control - the emergence of an efficient, flourishing and stable market - needs to be prevented. Coffey does not tell us.
G. E. Wood,
Europeun
monetuty
integration?
333
Chapter 8 is called ‘The Money Supply Question’. The particular question he has in mind is what is the most appropriate definition of the money supply to control with the aim of controlling inflation. He does not, however, attempt to answer this question by applying the well-known criterion of seeking that aggregate which minimises the combined effects of control error and prediction error. There is no mention of any criterion. There is, however, analytical confusion.3 Coffey is concerned that different EEC member states target different monetary aggregates, but does not say why that is ‘disturbing’ (to use his word). If the EEC becomes a complete monetary union, this situation will certainly change, because the EEC will then have a common (European) currency. But until that stage there is no problem. Coffey recommends (p. 51) that the ‘. . . Community should develop a European Capital Market’. First, why is there any necessity for the EEC to develop such a market? There already are active Euro-dollar and (somewhat less active) Euro-sterling markets. If any other markets seem desirable, why will profit maximisation not lead to them developing? Coffey does not address this elementary but important point. Instead he lists the benefits which he expects to flow from the emergence of such a market. Some of these are grotesque. The market will, he says, ‘lead to a greater transparency in the supply of funds.. . ’ (p. 51). What does that mean?4 It would ‘probably help regional needs.. . some Member States would insist on the creation of real Community regional plans, more generous regional funds.. . ’ (p. 51). Why is waste of money additional to the extraordinary profligacy of many EEC plans good news, except for the bureaucrats who would disburse other people’s money? On p. 66, we find again his hankering for regulation: ‘However, concerning an orderly management of the capital markets - which is a necessary prerequisite for the smooth functioning of such institutions - national bodies could be replaced by a Community Capital Issues committee - as the author suggested several years ago.’ Why is that desirable? The purpose of the U.K. Capital Issues Committee was to maintain a queue of prospective borrowers on capital markets. No justification has ever been provided for this being done by some branch of government. If the task were useful, the market would soon do it for itself. One can only be grateful that Peter Coffey’s suggestion has so far been ignored. Coffey thinks a ‘European Monetary Fund’ should be established. He assigns to this Fund numerous responsibilities. One of these is that it should be ‘ . . . responsible for the future creation of any new issues of ECUs’ (p. 91). At this point one starts to wonder if Peter Coffey knows what an ECU is. It is -‘There are also factual errors in his description of the conduct of monetary policy in the UK. 4Sir John Hicks (1979) has used the term ‘transparency’ in a discussion of narrowing of the Edgeworth core, so the term is not new to economics. But what Coffey means by it is puzzling.
334
G. E. Wood,
European
ntorretury
inregrufiotr?
an average of all the EEC’s national currencies. Therefore, it follows that if any commercial bank is to accept a deposit or make a loan denominated in ECUs, it should have access to the appropriate set of national currency reserves. The central banks which supply these currencies can act as lenders of last resort and, one hopes, will control the supply. That in turn will control the supply of ECUs. The book concludes with a section entitled ‘The Future of the EMS Towards an EMU? That is a useful subject on which to conclude. After his sensible initial observation that as inflation rates within the EEC have moved closer together a necessary precondition for fixed exchange rates is closer to being satisfied, these chapters say little of substance. The subject is, however, worth discussing, and the penultimate section of this review deals with it. 5. Whither the EMS? At the moment, the EMS can be described by three main features. These are the arrangement for pegging exchange rates, the system of credit facilities to help defend those pegged rates, and a proposed ‘European Monetary Fund’ (EMF). Rates are tied together in a system of mutually agreed and consistent cross-rates; this is in contrast to another initially considered scheme, under which rates would have been tied to a weighted average of all the member countries’ currencies.’ Loans to enable intervention are made directly from one country to another. The loans are in three maturity categories - repayable within 45 days, within 9 months, and within 5 years. The amount available under the first facility is supposedly unlimited; under the second and third, 14 billion and 11 billion ECUs - roughly US$18 billion and US$14 billion, respectively. The EMF is intended to have pooled under its control a portion of the gold and dollar reserves of the member countries, and to give these members deposits, denominated in ECUs, at the EMF. Pending final establishment of the EMF, reserve pooling has been carried out in the form of revolving 3-month swaps among the separate national monetary authorities. Is there any prospect of this system evolving into a complete European Monetary Union? Certainly the system as at present established - as distinct from the particular set of exchange rates - seems sustainable. Rates will not stay pegged for ever; countries are not so committed to that objective as to subordinate all policies to it. The DM - and if Britain joins, Sterling - will behave quite differently from the other EMS currencies when there are major movements of capital, for only the capital markets of these countries are sufficiently deep to absorb funds on a substantial scale. But a system of ‘fixed ‘The choice was made on the basis of the belief that the sys!em chosen would create an obligation for all countries to adjust whenever one currency moved, for movement by one would, in contrast to the other system, shift all other rates from their agreed level. A good description of all these institutional characteristics can be found in Bank of England (1979).
G. E. Wood,
European
monetor?,
integration?
335
but adjustable’ rates could certainly persist. Should it? Fixed but adjustable rates are not costless to maintain, and the benefits are not clear - in contrast to both genuinely fixed rates and freely floating rates with a preannounced monetary policy. Should there be a move to a genuine monetary union? No-one has yet successfully argued that the EEC is an optimal currency area, and all the nation states within it are feasible currency areas (with the exceptions perhaps of Belgium and Luxembourg). In other words, the case.for EMU has yet to be made. That of course does not mean it will not happen. But there is one substantial institutional impediment. The power to print money brings with it the power to tax. Whoever issues money gains control over real resources by doing so. There would have to be agreement on the distribution of the resources which would accrue to the European Central Bank. There has been little official discussion of the establishment of such a central bank, and none of how its revenue from money creation would be distributed.
6. Summary and conclusions Peter Coffey’s book is a bad book on an interesting subject. Not only is the level of economic analysis low, but the book is badly written, In the ‘Notes about the Author’ it is stated that Peter Coffey speaks seven languages; one can only regret that one of them is not English. As to the prospects for European monetary integration, if by this is meant a complete union rather than the already existing pseudo union, these prospects seem rather slight. Truly fixed exchange rates would in effect imply a common currency. There is not at the moment any political pressure which could move the EEC towards that. Further, it is far from clear that such a change would produce gains additional to those which would result from the absence of controls and the presence of credible pre-announced national monetary policies.
References Bank of England 1979, Intervention arrangements in the European monetary system, Quarterly Bulletin, June, 190-194. Corden, W.M., 1972, Monetary integration, Princeton essays in int~rnationai finance no. 93 (Princeton University, Princeton, NJ). Corden, W.M., 1973, The adjustment problem, in: Lawrence B. Krause and Walter S. Sahnt, eds., European monetary integration and its meaning for the United States (Brookings, Washington, DC). Corden, W.M., 1980, Inflation, exchange rates, and the world economy, 2nd ed. (Clarendon Press, Oxford). Hicks, Sir John, 1979, Review of ‘Microfoundations: The compatibility of microeconomics and macroeconomics’ by E. Roy Weinbtraub, Journal of Economic Literature 17, 1451-1454.
336
G. E. Wood,
European
monetan
integration?
Ingram, J.C., 1959, State and regional payments mechanisms, Quarterly Journal of Economics 73, 619-632. Ingram, J.C., 1962, Regional payments mechanisms: The case of Puerto Rico (University of North Carolina Press, Chapel HiB, NC). McKinnon, R.I., 1963, Optimum currency areas, American Economic Review 53,717-727. MundeU, R.A., 1961, A theory of optimum currency areas, American Economic Review 51, 657-665. Wood, G.E., 1983, ‘Ihe European monetary system, in: R. Jenkins, ed., Britain and the EEC (Macmillan, New York).
EUROPEAN
MONETARY INTEGRATION? A Review Essay Geoffrey E. WOOD*
The Ci!v
Uniuersip.
London
EC2 Y 8HB.
England
1. Introduction There have been several proposals for the creation of a European Monetary System. In his recent book - The European Monetary System: Past, Present and Future (Martinus Nijhoff Publishers, Amsterdam, 1984) - Peter Coffey considers these existing European monetary plans, and makes some suggestions of his own to further monetary integration in Europe. The book is in eight parts, comprising fifteen chapters plus a section headed ‘Conclusions’. The subjects covered are a survey of the historical background, a description of the system, various considerations - technical, capital market, and institutional - relevant to its future, and discussion of interactions between EMS member countries and others. In appraising both this book and the prospects for monetary integration in Europe, it should be borne in mind that pressure for European monetary integration has largely been produced from political motives. It has been urged by advocates of political union in Europe, who saw it as a further step towards their goal of a ‘United States of Europe’. Discussion has been of how to achieve monetary integration rather than of whether it is desirable. Indeed, and no doubt in some cases deliberately, it has been left obscure what advocates of European monetary integration mean by monetary integration. It is therefore useful first to set out some basic analytical points. 2. The meaning of monetary integration Monetary integration must mean that there is complete freedom for both current and capital account transactions within the integrated area. There must be no exchange controls or any equivalent restrictions. These conditions could of course be satisfied under freely floating exchange rates, the extreme of *I am indebted to Dr. A.B. Balbach. Professor M.D. Bordo, Dr. F.H. Capie, Professor H. Grossman, Professor L. Pressnell and Dr. Anna J. Schwartz for their comments on a preliminary version of this review. 0304-3923/86/$3.5001986.
Elsevier Science Publishers B.V. (North-Holland)
330
G. E. Wood.
European
monetary
integration?
monetary independence. Accordingly, then, monetary integration must comprise in addition an exchange rate union - the fixing of exchange rates against each other within the integrated area and a common arrangement towards currencies not in the union. Such an exchange rate union can be either a ‘pseudo union’ or a ‘complete union’. (To use the terms coined by Max Corden in 1972.) The first is an agreement to fix exchange rates, the agreement perhaps being accompanied by promises of economic policy coordination; the second involves pooling of foreign exchange reserves, establishment of a central bank for the monetary union, and the issue of a common currency for the union. The first is a Bretton Woods type system. Under Bretton Woods, surplus and deficit countries eventually changed their exchange rates rather than continue to inflate or deflate. As a result of that experience countries which formed a pseudo-union would be expected to behave that way now, so that there would be a flood of funds across the exchanges whenever a country seemed under pressure to change policy. That flood would then precipitate the exchange rate change. Indeed, it has been the experience of the European Monetary System (EMS) to date that countries have changed exchange rates fairly readily. Policy has not been subordinated to irrevocable pegging of the exchange rate. Suppose, however, that there were the political will in Europe to create a complete European Monetary Union. Would its creation be desirable? 3. Arguments for monetary union A large part of discussion of this issue has been in the setting of a stable, non-vertical, long-run Phillips curve. For example Corden (1973) saw as a major problem for European Monetary Union that countries would be forced away from their preferred inflation/unemployment combinations. Some countries would, he feared, become permanently depressed areas as a result of being forced to choose lower rates of inflation than they would without the fixed exchange rate constraint.’ With that difficulty removed as a result of both theoretical developments and the experience of the 197Os* the way seems clear to monetary union. That does not, however, mean a union should be formed. Feasibility is not optimality. There is a small body of literature on the choice of optimal domain for a currency. The main contributions are Ingram (1959,1962), Mundell (1961), McKinnon (1963), and Corden (1972,1973). ‘That countries might experience permanent high unemployment as a result of a fixed exchange rate was also feared by some ministers (notably Ernest Bevin) in the war-time British government. This led to the so-called ‘Catto Clause’ being negotiated at the Atlantic City pre-Bretton Woods meeting in late June and early July 1944. This clause ensured ultimate national sovereignty over exchange rate changes. (Lord Catto was Governor of the Bank of England.) ‘As noted by Corden (1980, ch. 10).
G. E. Wood,
European
monetary
integration?
331
Mundell, writing implicitly within the Phillips curve framework, argued that the optimum currency area is the area of factor mobility - so long as factors, particularly labour, are mobile, there will be no need for exchange rate changes to change real wages and hence the unemployment rate. McKinnon made an opposing point - if a region were very open, so that a large part of what was used was tradable, then exchange rate changes might not change real wages. Indeed, perhaps not very likely except under conditions of high inflation and incipient currency collapse but certainly a possibility, wage bargains might not be struck in terms of domestic currency. Corden’s contribution was threefold. He developed the concept of a feasible currency area, and refined both McKinnon’s and Ingram’s arguments. A feasible area is one which can have its own currency, and the associated possibility of exchange rate changes. It is not so involved in trade with some other country that it simply uses that other country’s currency. McKinnon’s argument was essentially one for choice of currency domain on grounds of what would yield the greatest stability of the price level. When should one want fixed rates to impart price level stability? The answer depends not only on the openness of the economy, as McKinnon conjectured, but also on the source of the disturbance. If the disturbance is a change in the foreign price level, then domestic price stability requires an exchange rate change. Only if disturbances are domestic is the effect of a fixed exchange rate stabilising, via stabilising the price of traded goods. Ingram argued from the experience of Puerto Rico that a pegged exchange rate encouraged capital mobility, and this prevented the emergence of the depressed areas which Corden (and others) feared. The argument is straightforward. There is a decline in demand for the principal export of some area. Workers become unemployed. On seeing this, capital (free of exchange risk) flows in, and the workers become employed in a new industry. However, if the workers became unemployed because they had pushed up wages there would be no incentive for capital to flow in; capital mobility would not remove this difficulty. As Corden observed in his interchange (1973) with Ingram, the source of the disturbance is crucial, just as it is in McKinnon’s argument. Those few points summarise the theory of optimum currency areas, so far as it goes. It is clear that what the theory comprises is not a framework within which a proposal for a monetary union can be rigorously appraised, but rather a set of points to be considered in the course of discussing such a proposed union. 4. Any advance? How does Peter Coffey’s book advance our understanding of either the theory of monetary union, as sketched above, or of the application of it to appraising the desirability and prospects of European monetary integration? The answer is, not at all. Peter Coffey asserts (p. 2) that ‘. . . theoretical
332
G. E. Wood.
Europeart
nlotletaty
integration?
considerations have, at all times, been in the author’s mind’. They may have been in his mind, but they are seldom brought into use. In the preface (p. 2) he describes an optimum currency area as a set of countries having a ‘similar propensity to inflate’. What is a propensity to inflate? Is it a fundamental behavioural characteristic, like a propensity to save? We are not told. Suppose it just means inflation rate. Then if countries do have similar inflation rates, the major cause of exchange rate pressure is certainly removed. These countries could probably keep their exchange rates pegged. But that says nothing about whether it is optimal to do so. The first four chapters comprise a brief history of plans for European monetary integration, and description of its present institutional character. Chapter 5 moves on towards appraisal of the performance so far of the EMS. There are few problems with these chapters although the appraisal chapter is rather thin. Exchange rate variability within the EMS was indeed lower than among the EMS currencies before the introduction of the system. But the environment was different and there was a cost in terms of increased wnpredictable variability in other variables [see Wood (1983)]. Coffey does not mention these factors. There is an abundance of non-sequiturs: ‘. . . the ECU (European Currency Unit - roughly speaking, an average of EMS member currencies) is the third most important currency/reserve asset for the European Investment Bank and for Italy. Internationally it is among the top three currencies’ (what does that mean?) ‘and reserve assets. Therefore (emphasis added) the author proposes that all the Community Member States should agree to allow their citizens to hold private bank accounts in ECUs’ (p. 39). There is absolutely nothing wrong with the recommendation - it enlarges freedom of choice. But it certainly does not follow from the statements which precede it. It would be possible to continue for page after page in this vein, but it would serve little purpose. It is, however, essential to deal with certain proposals and comments which are certainly misleading and in some cases potentially harmful. Peter Coffey is strongly in favour of intervention in and control over financial markets by monetary authorities. Indeed, he favours the creation of what he rather quaintly terms a ‘central organ’ for this purpose. ‘. . . the need for a greater Community control over the ECU markets will grow. In turn, this underlies the need for a real European Monetary Fund.. . ’ (p. 40). Why do these markets need controlling? Coffey argues from the history of the Euro-dollar market. ‘Preferably, the, situation of the Euro-dollar market, with all the implications of lack of community control - should not be allowed to be repeated in the ECU Bond market’ (p. 38). What is puzzling is why the major implication of lack of control - the emergence of an efficient, flourishing and stable market - needs to be prevented. Coffey does not tell us.
G. E. Wood,
Europeun
monetuty
integration?
333
Chapter 8 is called ‘The Money Supply Question’. The particular question he has in mind is what is the most appropriate definition of the money supply to control with the aim of controlling inflation. He does not, however, attempt to answer this question by applying the well-known criterion of seeking that aggregate which minimises the combined effects of control error and prediction error. There is no mention of any criterion. There is, however, analytical confusion.3 Coffey is concerned that different EEC member states target different monetary aggregates, but does not say why that is ‘disturbing’ (to use his word). If the EEC becomes a complete monetary union, this situation will certainly change, because the EEC will then have a common (European) currency. But until that stage there is no problem. Coffey recommends (p. 51) that the ‘. . . Community should develop a European Capital Market’. First, why is there any necessity for the EEC to develop such a market? There already are active Euro-dollar and (somewhat less active) Euro-sterling markets. If any other markets seem desirable, why will profit maximisation not lead to them developing? Coffey does not address this elementary but important point. Instead he lists the benefits which he expects to flow from the emergence of such a market. Some of these are grotesque. The market will, he says, ‘lead to a greater transparency in the supply of funds.. . ’ (p. 51). What does that mean?4 It would ‘probably help regional needs.. . some Member States would insist on the creation of real Community regional plans, more generous regional funds.. . ’ (p. 51). Why is waste of money additional to the extraordinary profligacy of many EEC plans good news, except for the bureaucrats who would disburse other people’s money? On p. 66, we find again his hankering for regulation: ‘However, concerning an orderly management of the capital markets - which is a necessary prerequisite for the smooth functioning of such institutions - national bodies could be replaced by a Community Capital Issues committee - as the author suggested several years ago.’ Why is that desirable? The purpose of the U.K. Capital Issues Committee was to maintain a queue of prospective borrowers on capital markets. No justification has ever been provided for this being done by some branch of government. If the task were useful, the market would soon do it for itself. One can only be grateful that Peter Coffey’s suggestion has so far been ignored. Coffey thinks a ‘European Monetary Fund’ should be established. He assigns to this Fund numerous responsibilities. One of these is that it should be ‘ . . . responsible for the future creation of any new issues of ECUs’ (p. 91). At this point one starts to wonder if Peter Coffey knows what an ECU is. It is -‘There are also factual errors in his description of the conduct of monetary policy in the UK. 4Sir John Hicks (1979) has used the term ‘transparency’ in a discussion of narrowing of the Edgeworth core, so the term is not new to economics. But what Coffey means by it is puzzling.
334
G. E. Wood,
European
ntorretury
inregrufiotr?
an average of all the EEC’s national currencies. Therefore, it follows that if any commercial bank is to accept a deposit or make a loan denominated in ECUs, it should have access to the appropriate set of national currency reserves. The central banks which supply these currencies can act as lenders of last resort and, one hopes, will control the supply. That in turn will control the supply of ECUs. The book concludes with a section entitled ‘The Future of the EMS Towards an EMU? That is a useful subject on which to conclude. After his sensible initial observation that as inflation rates within the EEC have moved closer together a necessary precondition for fixed exchange rates is closer to being satisfied, these chapters say little of substance. The subject is, however, worth discussing, and the penultimate section of this review deals with it. 5. Whither the EMS? At the moment, the EMS can be described by three main features. These are the arrangement for pegging exchange rates, the system of credit facilities to help defend those pegged rates, and a proposed ‘European Monetary Fund’ (EMF). Rates are tied together in a system of mutually agreed and consistent cross-rates; this is in contrast to another initially considered scheme, under which rates would have been tied to a weighted average of all the member countries’ currencies.’ Loans to enable intervention are made directly from one country to another. The loans are in three maturity categories - repayable within 45 days, within 9 months, and within 5 years. The amount available under the first facility is supposedly unlimited; under the second and third, 14 billion and 11 billion ECUs - roughly US$18 billion and US$14 billion, respectively. The EMF is intended to have pooled under its control a portion of the gold and dollar reserves of the member countries, and to give these members deposits, denominated in ECUs, at the EMF. Pending final establishment of the EMF, reserve pooling has been carried out in the form of revolving 3-month swaps among the separate national monetary authorities. Is there any prospect of this system evolving into a complete European Monetary Union? Certainly the system as at present established - as distinct from the particular set of exchange rates - seems sustainable. Rates will not stay pegged for ever; countries are not so committed to that objective as to subordinate all policies to it. The DM - and if Britain joins, Sterling - will behave quite differently from the other EMS currencies when there are major movements of capital, for only the capital markets of these countries are sufficiently deep to absorb funds on a substantial scale. But a system of ‘fixed ‘The choice was made on the basis of the belief that the sys!em chosen would create an obligation for all countries to adjust whenever one currency moved, for movement by one would, in contrast to the other system, shift all other rates from their agreed level. A good description of all these institutional characteristics can be found in Bank of England (1979).
G. E. Wood,
European
monetor?,
integration?
335
but adjustable’ rates could certainly persist. Should it? Fixed but adjustable rates are not costless to maintain, and the benefits are not clear - in contrast to both genuinely fixed rates and freely floating rates with a preannounced monetary policy. Should there be a move to a genuine monetary union? No-one has yet successfully argued that the EEC is an optimal currency area, and all the nation states within it are feasible currency areas (with the exceptions perhaps of Belgium and Luxembourg). In other words, the case.for EMU has yet to be made. That of course does not mean it will not happen. But there is one substantial institutional impediment. The power to print money brings with it the power to tax. Whoever issues money gains control over real resources by doing so. There would have to be agreement on the distribution of the resources which would accrue to the European Central Bank. There has been little official discussion of the establishment of such a central bank, and none of how its revenue from money creation would be distributed.
6. Summary and conclusions Peter Coffey’s book is a bad book on an interesting subject. Not only is the level of economic analysis low, but the book is badly written, In the ‘Notes about the Author’ it is stated that Peter Coffey speaks seven languages; one can only regret that one of them is not English. As to the prospects for European monetary integration, if by this is meant a complete union rather than the already existing pseudo union, these prospects seem rather slight. Truly fixed exchange rates would in effect imply a common currency. There is not at the moment any political pressure which could move the EEC towards that. Further, it is far from clear that such a change would produce gains additional to those which would result from the absence of controls and the presence of credible pre-announced national monetary policies.
References Bank of England 1979, Intervention arrangements in the European monetary system, Quarterly Bulletin, June, 190-194. Corden, W.M., 1972, Monetary integration, Princeton essays in int~rnationai finance no. 93 (Princeton University, Princeton, NJ). Corden, W.M., 1973, The adjustment problem, in: Lawrence B. Krause and Walter S. Sahnt, eds., European monetary integration and its meaning for the United States (Brookings, Washington, DC). Corden, W.M., 1980, Inflation, exchange rates, and the world economy, 2nd ed. (Clarendon Press, Oxford). Hicks, Sir John, 1979, Review of ‘Microfoundations: The compatibility of microeconomics and macroeconomics’ by E. Roy Weinbtraub, Journal of Economic Literature 17, 1451-1454.
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Ingram, J.C., 1959, State and regional payments mechanisms, Quarterly Journal of Economics 73, 619-632. Ingram, J.C., 1962, Regional payments mechanisms: The case of Puerto Rico (University of North Carolina Press, Chapel HiB, NC). McKinnon, R.I., 1963, Optimum currency areas, American Economic Review 53,717-727. MundeU, R.A., 1961, A theory of optimum currency areas, American Economic Review 51, 657-665. Wood, G.E., 1983, ‘Ihe European monetary system, in: R. Jenkins, ed., Britain and the EEC (Macmillan, New York).