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European economic integration.

European Economic Integration

Twenty-five economists from the United States and Europe met in Cambridge on August 3-4 for a conference on "European Economic Integration: Towards 1992" sponsored by the NBER and the Centre for Economic Policy Research (CEPR). Willem H. Buiter, of NBER, Yale University, and CEPR, organized the following program:

Jeffrey D. Sachs, NBER and Harvard University; and

Xavier Sala-I-Martin, Harvard University, "Federal

Fiscal Policy and Currency Unions: Some Lessons

for Europe from the United States"

Discussant: Willem H. Buiter

Francesco Giavazzi, NBER, University of Bologna,

and CEPR; and Marco Pagano, University of Naples

and CEPR, "Confidence Crises and Public Debt

Management"

Discussant: Kenneth Kletzer, Yale University

Clas Wihlborg, Gothenburg University and University

of Southern California, "Exchange Rate

Arrangements for the Transition to a Common Currency"

(jointly with Thomas Willett, University of

Southern California)

Discussant: Vittorio U. Grilli, NBER, Yale University,

and CEPR

Richard E. Baldwin, NBER and Columbia University,

"On the Growth Effects of 1992" (This paper is

described in "International Seminar on

Macroeconomics.")

Discussant: David Ulph, University of Bristol and

CEPR

Rick van der Ploeg, Center for Economic Research,

Tilburg University, and CEPR, "Fiscal Aspects of

Monetary Integration in Europe"

Discussant: Silvio Borner, University of Basel

Damien J. Neven, INSEAD and CEPR, "European

Integration and Trade Flows" (jointly with Lars-Hendrik

Roller, INSEAD)

Discussant: Alan Winters, University College of North

Wales and CEPR

Vittorio U. Grilli and Nouriel Roubini, NBER and Yale

University, "Financial Integration, Liquidity, and

Exchange Rates"

Discussant: Lars E. O. Svensson, NBER and

University of Stockholm

Sachs and Sala-I-Martin discuss the role of a federal fiscal government in a monetary union. They argue that a monetary union is more likely to survive if it is accompanied by a federal government that redistributes income from positively to adversely shocked regions so as to make nominal exchange rate adjustments less necessary. They find that, within the United States, a one dollar negative shock to the average U.S. region triggers higher federal transfers (between 6 and 10 cents) and lower federal taxes (between 28 and 30 cents), so the decrease in disposable income is only about 62 to 65 cents. Hence, more than one-third of the shock is absorbed by the federal government and most of the action comes from the tax side. They suggest that, without a fiscal union, a European Monetary Union (EMU) is not likely to survive.

Giavazzi and Pagano argue that under free capital mobility, confidence crises can result in devaluations if fiscal authorities can obtain temporary money financing, even when fixed exchange rates are viable. During a crisis, domestic interest rates increase, reflecting the expected devaluation. Rather than selling debt at punitive rates, fiscal authorities may turn to temporary money financing, leading to equilibriums with positive probability of devaluation. These equilibriums can be ruled out if the amount of debt maturing during the crisis is sufficiently small: a condition that can be met by reducing the stock of public debt, lengthening its average maturity, and/or smoothing the time distribution of maturing issues.

Wihlborg analyzes the transition from the current "fixed but adjustable" exchange rate system among most members of the European Community (EC) to an irrevocably fixed system within which a common currency gradually would be substituted for the old national currencies. Wihlborg argues that basic conflicts between short-run political goals and economic efficiency are likely to arise during any attempted transition. Strategies that provide the greatest short-term benefits to national governments therefore may not provide the most efficient path for securing the longer-run objective of monetary union. Ironically, the possibility exists that, the more closely the economies moving toward monetary union meet some of the criteria for an optimal currency area emphasized in the traditional literature, the greater is the likely conflict between short-run political incentives and efficient paths toward full monetary union.

Van der Ploeg uses a two-country model to analyze fiscal aspects of monetary integration in Europe. When an adverse supply shock hits a two-country Mundell-Fleming world, it causes unemployment and a rise in the cost of living. He compares the optimal fiscal policies under international policy coordination with those pursued in the absence of international coordination. Van der Ploeg considers three exchange rate regimes: freely floating rates; managed exchange rates with hegemony (such as the European Monetary System [EMS]); and a symmetric regime of fixed exchange rates (like certain versions of the proposed EMU). He also considers the effects of comprehensive economic integration (1992), of indexation of wages to the cost of living, and of interactions and spillovers between Europe and the United States.

Neven studies intra-European trade flows and trade between Europe and the rest of the world for 29 manufacturing sectors over 1975-85. Contrary to some claims, European integration has not slowed down in recent years. Rather, European integration has proceeded alongside integration with the rest of the world. Neven finds evidence of significant unexhausted scale economies in European industry. Nontariff barriers to trade hamper trade between Europe and the rest of the world significantly more than they hamper intra-European trade.

Grilli and Roubini ask two questions suggested by the EC's decision to liberalize capital movements by 1990. First, will capital liberalization make it harder to maintain fixed exchange rate parities in the EMS area? Second, given the existence of large budget deficits and high public debt-GDP ratios in a number of EMS countries, will capital liberalization (together with the need to maintain fixed parities) make the financing and management of public debt more difficult? Using a model that has "cash-in-advance constraints" for transactions in financial markets as well as for transactions in goods markets, they find that capital controls (in the form of taxes on foreign asset acquisitions) tend to appreciate the currency in the country imposing the controls. That is because the controls reduce the share of foreign money used for asset transactions and thus increase the share used for goods transactions. Also, a move by a country toward a longer maturity structure of the public debt will tend to depreciate that country's currency by reducing the share of the country's money used for asset transactions. Countries that are simultaneously liberalizing capital movements and lengthening the maturity structure of their public debt therefore may expect to face a weakening of their currency. Finally, even when the monetary and real "fundamentals" are not subject to uncertainty, uncertainty about the process governing public debt issues can lead to volatility of nominal and real exchange rates. This increases the burden put on monetary policies in the pursuit of exchange rate stability.
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Title Annotation:conference
Publication:NBER Reporter
Date:Sep 22, 1989
Words:1085
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