After World War II, in 1944 to reconstruct the world economy delegates from 44 countries met at Bretton Woods.(Eichengreen, B. ,2010) The designers of this new international monetary system were John Maynard Keynes from Britain and Harry Dexter White, the chief international economist of the Treasury Department of United States of America.
(Eichengreen, B. ,2010)White’s plan in 1942 had premises on world peace. (Eichengreen, B. ,2010) He looked beyond and saw economic challenges of the future.
(Eichengreen, B., 2010) He set out “three inescapable problems” that United States would face in the immediate postwar world. (Eichengreen, B., 2010) Firstly, to prevent disruption of foreign exchange and the collapse of monetary and credit system. (Eichengreen, B.
, 2010) Secondly, to assure the restoration of foreign trade and thirdly, to supply the huge volume of capital that will be needed virtually throughout the world for reconstruction for relief and economic recovery. (Eichengreen, B., 2010) A stabilization fund was described as a convenient instrument to countries which would ensure stability of exchange rates and convertibility of currency for orderly international trade. (Eichengreen, B., 2010) He also proposed a bank which would help in reconstruction and development of the economies of the countries that participated in the Second World War. (Eichengreen, B.
, 2010)Similarly, Keynes wanted a system that would support liberalized trade while keeping global payments away from economic pain. Keynes proposed a world bank “International Clearing Bank” to create supranational money, whose function would be to help countries manage balance-of-payments problems without deflation. (Eichengreen, B. ,2010) All the international transactions would be settled through “International Clearing Bank”. Further, Keynes proposed national central banks would buy and sell their own currencies among themselves by means of debit and credits in newly created “bank money” to their ICB. (Eichengreen, B. ,2010) If the country imported goods “bancor” would be subtracted from their ICB and if the country exported goods “bancor” would be added to their ICB.
(Eichengreen, B., 2010)”Bancor” would create an orderly fashion of relative exchange rates of different national currencies. (Eichengreen, B., 2010)Hence, Keynes “Bancor” and White’s “Unitas” were the two proposals for reconstruction of economy after Second World War. “Unitas” was aimed to becoming an international currency, where else “bancor” was reducing the global dependence on gold, since Keynes did not support gold standard. Since, Britain wanted Pound-based economy and US wanted dollar based economy. Being at odds with each other both the sides dropped the idea quietly at the summit.
Eventually, Bretton Woods collapsed which involved sequential withdrawal of convertibility of gold into dollars, thereby ending the role of gold as a liquid dollar claim, and the end of the unified fixed exchange rate regime from 1968 through 1973. (Peter M. Garber, 2017) It was during 1960s that Robert Mundell, came up with the pros and cons of an “Optimum Currency Area”. In detail, an optimum currency area is an economic unit composed of regions affected symmetrically by disturbances and between which labour and other factors of production flow freely.(IMF, 2017) Mundell gives strong preference for a Greenspan-style monetary policy, where price stability is the only goal.
(Anon, 2017) He believed when countries try to use their policy to inflate foreign debt away or spur employment growth, they go awry.(Anon, 2017) Moreover, Mundell described optimum currency area where floating exchange rates despite the fact that they help absorb asymmetric shock, are seen as huge barriers before countries become Single Market Programme because floating exchange rates can lead to instability and macroeconomic complications. The high volatility of exchange rates is unpredictable in the short-run, they increase the risk for participants in financial markets which implies less foreign direct investment for a country, and at times floating-exchange rate increases the complications such aggregation of poverty because of such reasons, some countries have given up their independent currencies. For example, Ecuador, El Salvador and Panama have adopted the US dollar and Kosovo and Montenegro the euro.
(Coy M., 2017) Mundell further believed floating exchange rates were used as an opportunity for banks and hedge funds to make money at the expense of people doing internationally. (Anon, 2017) To be Optimum Currency Area the countries also have to sacrifice their monetary policies, which are seen as huge instruments for countries. Every country likes to have their regionally prefered monetary policy. Therefore, the reason Robert Mundell supports “Bancor” and “Unitas” is because White’s proposal had “stabilization fund” which promoted stability of exchange rate and Keynes “International Clearing Bank” supported stability of exchange rate. All three of them understood the importance of trade and globalisation in the future. Therefore, according to Mundell Bretton Woods collapsed because they failed to adopt a unified currency and fixed exchange rate.
The traits of OCA. In today’s time European Monetary Union is theoretically seen as an example of OCA. Integration of countries but integration led by abolishment of trade barriers, mobility of labor, unified currency, and risk sharing system. However, economist’s like Milton Friedman, Bayoumi and Eichengreen argue that Europe is not an Optimum Currency Area, we shall analyse that in detail. B. Analyses of European Monetary UnionOCA literature does not provide a formal test through whose application the hypothesis can be accepted or rejected.(Barry Eichengreen, 1991 )This is why we will look if European Union lives up to OCA depending on factors such as real exchange rate, if shocks are symmetric, labor mobility, business cycle synchronization and regional self insurance.1.
2 Symmetric ShocksTamim Bayoumi and Barry Eichengreen, in 1991 used the methodology extension of Blanchard and Quah (1989) decompositions of output into permanent and transitory shocks. (Blanchard and Quah, 1989) To identify supply and demand disturbances they estimated bivariate vector autoregression for each country and region. Bayoumi and Eichengreen came to the conclusion that there is a core consisting of Germany, France, Belgium, Netherlands and Denmark where the shocks were highly correlated and there is a periphery consisting of Greece, Ireland, Italy, Portugal and UK where correlation is lower. (Appendix A) Nauro F Campos and Corrado Macchiarelli professors from Brunel University and London School Economic updated the research of Bayoumi and Eichengreen and came to a more satisfactory conclusion for the EMU. The standard AD-AS model implies that demand shocks should raise price in both the short and long run, while supply shocks should lower prices and increase demand.(Macchiarelli, C. and Campos, N.
,2016) To achieve this, they took four restrictions into considerations, where else Bayoumi and Eichengreen took three. Adding this new restriction they come to the conclusion, that EMU has changed over the years. Bayoumi and Eichengreen observation have been weakened and there are changes in the clustering of countries. (Macchiarelli, C. and Campos, N.,2016) (Appendix B) From Nauro and Corrado’s conclusions we can say the core countries have dispersed in comparison to Bayoumi and Eichengreen observation, they also concluded that countries like Spain, Ireland, Portugal and Greece have seen lower growth over the years in comparison to Germany.
European Monetary Union has common monetary policies and tries to keep the prices stable all over Europe, however most of its decisions of controlling money supply and interest rates are made according to the majority of the countries in the union. Before Greece joined the eurozone, the greek economy was a mess, unemployment rates were high, prices were surging, government debts ballooned and costs were high. In 2014 Greece was running with unemployment rate of 27.5%.
In contrast Germany had the unemployment rate of 5%. To reduce the unemployment Greece could have increased aggregate demand through monetary policies these were curbed by joining the European Union because monetary policies for the eurozone are set by the ECB. The ECB considers the whole of the Eurozone and so is not setting monetary policy for what Greece needs.Similarly, countries like Bulgaria and Romania, have per capita gross national income of 4,460 and 6,440 euros respectively, according to the World Bank. In comparison, the figure for France is of 34,000 and for Poland 9,480 euros.
(EURACTIV.com, 2017)To conclude, the shocks in European Union are not symmetric. European Union might have same monetary policy but governments have the autonomy over the fiscal policies of their countries which brings instability in countries (debt crisis) and for the European Union. Taking Nauro and Corrado’s research we we can also say that EMU is economically transforming in terms of symmetric shocks.1.2 Business Cycle SynchronisationEichengreen in a string of papers concluded that the cost of giving autonomy over monetary policy is especially high if business cycles of member states are only weakly correlated and alternative adjustment mechanisms, such as factor mobility are not sufficiently available.
(Belke, A., Domnick, C. and Gros, D., 2017) Lourdes Acedo Montoya and Jakob de Haan wrote research paper ‘Regional business cycle synchronization in Europe’ in 2008 . They analysed NUTS-1 region countries using the gross value added for period of 30 years (1975-2005) detrended by Hodrick-Prescott and Christiano-Fitzgerald filters. Using the correlation coefficient of the regional cycles with the Eurozone benchmark(gERMANY), they found that business synchronization has increased on average for the period considered with some exceptions during the eighties and the beginning of the nineties.
(Montoya, L. and de Haan, J., 2008)(Appendix C) But, the correlation of the business cycle in some regions with the benchmark remained low or even decreased.
(Montoya, L. and de Haan, J., 2008) Their research also supported the ‘national border’ effect which says nationalism and culture differences are positively related to consumer preferences for domestically produced goods. (Warwick.ac.
uk. ,2017) To bring in more evidence, on business cycle synchronisation in the EMU, we will bring in results from research article ‘Business Cycle Synchronization in the EMU: Core vs Periphery’ written by Ansgar Belke, Clemens Domnick and Daniel Gros in November 2016. They made use of adjusted GDP on a quarterly basis from the OECD. The dataset included all member states of the EU-12 plus Norway, Switzerland, Denmark and Sweden as non-EMU members, with data ranging from 1970Q1 to 2014Q4. They employed the Hodrick-Prescott(HP) filter to detrend the national real GDP series. The HP filter is simple estimation and implementation remains widely used in the business cycle literature. (Belke, A., Domnick, C.
and Gros, D., 2017) They made use of the correlation index developed by Cerqueira and Martins, 2009. They found this correlation index to be advantageous. They came to conclusion, that correlation coefficients indicated that the synchronization of economic activity between these country clusters fell markedly in the period after the start of the financial crisis (2008Q1 – 2015Q4) compared to the pre-crisis period (1999Q1-2007Q4).
(Appendix D)(Belke, A., Domnick, C. and Gros, D., 2017) Moreover, peripheral countries became less aligned relative to both the core countries and other economies outside of the EMU in the crisis period. Furthermore, the peripheral countries became less aligned among themselves in contrast to the cluster of core countries that did not show any change synchronization between the pre and the crisis period.( Belke, A.
, Domnick, C. and Gros, D., 2017) To conclude, this tells us that countries in EMU have desynchronized business cycles. Core countries have synchronised business cycles.
Newly added countries and peripheral countries still lack the advantage of having synchronised business cycles some of the reasons are difference of culture and preferences between countries. 1.3 Capital MobilityCapital mobility is a crucial part of the financial integration. A well functioning economy needs a financial system that moves funds from people who save to people who have productive investment opportunities. (Škabi?, I., 2016) A financial is fully integrated when all participants on the market face a single set of rules when they decide to deal with those financial instruments and/or services; have equal access to the above-mentioned set of financial instruments and/or services, and are treated equally when they are active in the market. (Baele et al.
, 2004)Ines Kersan Skabic measured the capital mobility by following Chinn-Ito Index ( an index measuring a country’s degree of capital account openness), international investment position, FDI, bond yields and share of foreign assets and liabilities in GDP. She mainly researched EU new members Bulgaria, Croatia, the Czech Republic, Cyprus, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, Slovenia and Romania from 2004-2014. She concluded her research by observing mixed picture of capital market integration. She found Malta, Poland, and Croatia were integrated based on stock market capitalization ratio, Czech Republic and Slovakia were integrated based on interest rate spreads, Hungary, Croatia and Cyprus based on international investment position, the Czech Republic, Estonia, Hungary, and Latvia based on Cin-Ito index and Estonia, the Czech Republic and Hungary based on FDI Intensity. However, she also observed Hungary and the Czech Republic have a very high value of trade with EU member states above 70%.
Croatia is oriented towards the EU, but also its neighboring countries. (Škabi?, I. , 2016)To conclude, EMU has strong capital mobility debt crisis in countries like Greece, Ireland and Portugal is one such example however capital mobility to the newly joined and Eastern Block of countries remains low. In terms of capital mobility EMU is still transforming.1.4 Labor mobilityMigration can cushion the negative impact of adverse labour demand shocks on unemployment and thereby smooth the adjustment to heterogenous macroeconomic developments.
(Robert and Frank, 2010) Since 2009 the largest increase in inflows of EU-28 movers between 2009 and 2014 can be seen in Germany, Austria, the UK, Denmark and Finland. (Annual Report, 2016) The main countries of destination in 2015 remain unchanged, with Germany continuing to accommodate the greatest number of EU-28 movers of working age, at 2.7 million, 22% of all EU-28 movers. UK, Spain, Italy, France and Switzerland host almost 75% of the EU-28 movers.(Annual Report, 2016) However, Slovakia, Bulgaria, Latvia, Lithuania, Croatia, Poland and Romania show high emigration rates between 2009 and 2012.(Annual Report, 2016) Despite policies like schengen agreement and common currencies labor mobility remains might have increased in countries like UK, Germany, Austria and Denmark but countries like Slovakia, Bulgaria, Latvia, Lithuania, Croatia, Poland and Romania have high emigration and might become ‘brain dead’ with all their resources moving to developed regions of Europe.
Furthermore, to get a better flavor of labor mobility of EU economist like Piracha and Vickerman (2002) have bought comparison between European Union and US to asses the labor mobility. Findings indicate that if a comparison is drawn between cross-EU mobility and interstate mobility flows in the US, about 3% of the working age population moves to a different state every year, which brings a substantial difference when compared to the EU. (Theodos, 2006) US is not considered the best benchmark for the EU.
This is because of the following reasons US is a federal state, while the EU is not. (Steunpunt Werk.be.
, 2017)Moreover, the US is one nation, while the EU comprises many countries. Freedom of movement in the US is as old as the country itself, while it has only become a recent possibility in the EU. (Steunpunt Werk.be., 2017) Furthermore, there are language barriers, cultural differences and social barriers. Moving from east coast in the US is easier than moving from Barcelona to Ireland. To conclude, most studies analysing the possible effects of the EMU process following the Optimum Currency Areas approach conclude that the success of the EMU (when benefits overweight costs) will depend on the capacity of European economies to give more flexibility to markets – both labour and goods and services markets – and also on the degree of symmetry of future shocks (Ramos et al.
, 1999). In EMU we can observe human resource from countries like Latvia, Romania, Ireland are migrating to more developed countries like Germany and UK. If this pattern continues these countries might become brain dead. Therefore, labor mobility in EMU is not what Mundell had described.1.5 ObjectivesWhen a group of countries decide to give up national currencies and form a currency union, it usually pursues a common objective.
(Jager, J. and Hafner, K. 2013) German government want to promote economic integration in order to transform the EMU into a real fiscal union. However, countries like Greece still want to get out of the union because of the amount debts.
Moreover, some countries support the idea of Eurobonds in order to unify Europe’s debts and idea which is rejected by the German government. The difference in opinion of the leaders can bring further instability in the EMU.(Jager, J.
and Hafner, K. 2013)To conclude, countries in the EMU have different objectives and want different outcomes from integration.1.6 OpennessThe openness of a country is measured by the number of exports and imports.
The country with the highest values of openness is Luxembourg – 139.1% in 2009 and 141.6% in 2010, the lowest values recorded in Spain, Greece, France and Italy, less than 25%. (Appendix E)(Teic? Ramona Andreea., 2013)From the analysis of the table (Appendix E) is noted that some countries are more involved than others in international trade and intra-EU relations are stronger than those outside the EU. Integration of financial markets is another important factor contributing to the theory of OCA.
(Teic? Ramona Andreea., 2013)To conclude, opennesses in EMU is not symmetric.ConclusionTo conclude, we can say during Bretton Woods the idea of unified currency was just seen as a theoretical idea that is why it was dropped.
In 1961 Mundell, came up with ‘OCA’ . Looking into symmetric shocks, labor mobility, capital mobility, objectives, openness and business synchronization of EMU, Robert Mundell’s analysis does not hold theoretically but it still holds empirically. EMU cannot be described as ‘Optimum Currency Area’, however it adopts certain traits from the OCA theory or we can say EMU is in the transition phase to become OCA or a even better economic architecture.