European Monetary Union Research Articles

Discipline or international balance: the choice of monetary systems in Europe

In retrospect and erroneously the nineteenth century international gold standard was interpreted as a quest for monetary discipline. The discipline argument was introduced after WWI in support for a restoration of the gold standard. The interwar failure led to an emphasis on international balances, the argument which came to the fore in the preparations for the Bretton Woods system. The balance argument was central in the early discussions of monetary union in Europe, but with the criticism of Keynesianism the discipline argument became determinant in the design of the Economic and Monetary Union.

Uncertainty and business cycle synchronization in Europe

ABSTRACT We assess empirically the role that uncertainty plays as a determinant of business cycle synchronization dynamics in the European Monetary Union. Using a time-varying measure of business cycle synchronization and Bayesian model averaging methods, we find that increase in uncertainty tends to robustly predict desynchronization, in particular for countries whose business cycles are not in line with those of the rest of the monetary union.

Frankel and Rose’s Introduction to the Endogeneity of Optimality: A Model Limited to the European Monetary Experience

This article discusses Frankel and Rose’s (1997, 1998) introduction to endogeneity, which was the result of scrutinizing the optimal currency area (OCA) theory through the evaluative lens of European monetary integration and unification in the 1990s. It cannot be generalized to another monetary union. The development of endogeneity interrelates five different criteria (common currency; transaction costs; commercial integration; economic convergence; and diversification of production) to argue that the introduction of a common currency leads to economic convergence among the participating countries. Frankel and Rose’s choice of analytic criteria arises from empirical studies on European monetary unification, following the OCA framework. The empirical studies found to have influenced the authors can be divided into three themes: the microeconomic benefits of a common currency; the optimality of European countries; and adjustment mechanisms. However, as shown by the selection of certain criteria, the influence of the Emerson report (1990), and the price-stability orientation of fiscal and monetary policies, their proposal only works within the monetary and economic conditions of the future eurozone area.

Central Counterparties are Too Big for the European Securities and Markets Authority (Alone): Constructive Critique of the 2019 CCP Supervision Regulation

Once seen as the solution to the systemic risk of over-the-counter derivatives, central counterparties (CCPs) have become a source of concern for the financial stability of the European Union (EU). Distress of a single CCP might be transferred to clearing members and others CCPs, thereby endangering EU monetary and fiscal stability. However, the European Market Infrastructure Regulation (EMIR) has left fiscal responsibility as well as day-to-day supervision of EU-based CCPs (EU-CCPs) at the national level, albeit cross-border colleges of authorities can overturn key decisions of national supervisors. The Commission concluded that these supervisory arrangements needed to be reformed because they hamper the development of a single coherent EU approach to CCP supervision. Although the Commission had proposed to centralise EU-CCP supervision in the European Securities and Markets Authority (ESMA), the final 2019 CCP Supervision Regulation seeks to improve EMIR’s ineffective collegial framework by establishing an internal CCP Supervisory Committee within ESMA. Nevertheless, the continuing lack of loss mutualisation would keep on hindering the development of a single approach to EU-CCP supervision. Moreover, the new regulation adds another layer of complexity to the EMIR framework and clashes with the European monetary constitution. If an agreement on loss mutualisation was reached, EU-CCP supervision should be centralised in two EU bodies along objective lines: while the European Central Bank should be tasked with EU-CCP prudential supervision, ESMA should be responsible for EU-CCP conduct of business supervision. This framework would improve EU-CCP supervision and fit in with the current EU governance at once.

A Dynamic Factor and Neural Networks Analysis of the Co-movement of Public Revenues in the EMU

This paper shows that the co-movement of public revenues in the European Monetary Union (EMU) is driven by an unobserved common factor. Our empirical analysis uses yearly data covering the period 1970–2014 for 12 selected EMU member countries. We have found that this common component has a significant impact on public revenues in the majority of the countries. We highlight this common pattern in a dynamic factor model (DFM). Since this factor is unobservable, it is difficult to agree on what it represents. We argue that the latent factor that emerges from the two different empirical approaches used might have a composite nature, being the result of both the more general convergence of the economic cycles of the countries in the area and the increasingly better tuned tax structure. However, the original aspect of our paper is the use of a back-propagation neural networks (BPNN)-DF model to test the results of the time-series. At the level of computer programming, the results obtained represent the first empirical demonstration of the latent factor’s presence.

Towards a dead end? EMU bond market exposure and manager performance

Using factor models we empirically investigate the performance of European Monetary Union (EMU) bond managers. We find that (1) alpha is time varying, (2) bond managers exhibit alpha in the short run as opposed to long-term prior to the Global Financial Crisis (GFC), and (3) bond fund alpha is associated with government bond funds and funds with heavy exposure to government bonds. Our factor models do not detect alpha in corporate and high-yield bond funds on average. We observe that alpha was much higher in the period prior to the GFC that began in 2008. The number of funds in our sample generating alpha dropped significantly after that crisis and remained very low from 2008 to 2017 as EMU markets recovered. We apply three models to evaluate EMU bond fund manager alpha. We use the two bond-market related Fama-French factors – term and default. In addition, we use the three equity market-related Fama-French factors – size, value, and market – together with the momentum factor. We find evidence that the bond market-related Fama-French factors are significant for the EMU bond funds in our sample, but the equity market-related Fama-French factors are not. By applying factor analysis to the returns of EMU bond funds, we (1) identify the economic drivers of EMU bond market returns and (2) show the performance of bond portfolio managers regarding alpha prior to the GFC and explain the possible lack of alpha after the GFC.

What Portfolio in Europe Makes Sense?

This article focuses on European bond and equity portfolios, and specifically the relevance of balanced portfolios. European equity and bond markets have undergone tremendous changes since the launch of the European Monetary Union (EMU) in 2000. Describing the risk–return profile of these markets provides valuable information about past structure and historical returns, and shifts the focus onto future expectations for institutional portfolios. The great volatility and low returns involved in European equity markets are a possible explanation for why investors prefer bonds that show Sharpe ratios higher than one. Taking into account five-year realized inflation, as well as strong bond market performance in the past 20 years with yields in the negative territory, the evidence indicates that the window for expected returns on balanced portfolios with large bond exposure is firmly shut. There are two challenging issues for European portfolio allocation. The first reflects the future of bond exposure in a balanced mandate. The second involves meaningful allocation to equity markets in a balanced portfolio. <b>TOPICS:</b>Security analysis and valuation, fixed income and structured finance, developed markets, portfolio construction <b>Key Findings</b> ▪ European bond markets have performed excellently in the last 20 years because of investor demand, capital inflows, and growth. The European bond market dominates in institutional portfolio allocations, and equity markets have been less attractive, given their risk–return characteristics. ▪ In a negative yield environment and where real equity returns are expected to be positive, it is questionable whether balanced allocation is capable of generating the desired financial outcomes. Foreign exchange, emerging market bonds, and global equities might provide desired returns for investors. ▪ Two challenging issues are involved in European portfolio allocation. The first reflects the future of bond exposure in a balanced mandate. The second involves meaningful allocation to equity markets in a balanced portfolio. Diversification has not disappeared, but finding expected returns might be challenging.

Effects of the European Monetary Union on High-Technology Exports

Our study estimates the effects of the European Monetary Union (EMU) on high-technology (HT) export and assesses the potential knowledge spillovers of such trade. Irrespective of the importance of the HT trade channel, none of the previous studies in the literature focus on the effects of a common currency on HT trade. Increasing trade in the HT sector may lead to more efficient use of resources and help countries to move towards a knowledge-based economy. Moreover, it may lead to higher overall growth. After considering multilateral resistances, pair fixed effects and bias correction in the preferred (three-way bias-corrected) model, EMU membership becomes negative and statistically non-significant for HT exports. Furthermore, our findings indicate that the effect of the EMU on HT exports is country-specific, which lends support to the notion of non-homogenous knowledge transfer and country-related knowledge-based economic development within the EMU.

Financial oversight, the third flawed pillar of the European Union: the missing piece in the Arestis-Sawyer critique of EMU macropolicy design

ABSTRACT This paper presents a chronological survey of the 20 academic papers that Malcolm authored or co-authored between 1997 and 2017 on the flawed design – and hence flawed implementation – of the European Monetary Union (EMU)’s macroeconomic policy pillars. We augment his analyses by pointing out a third – complementary – design flaw: the EMU’s two-tiered structure of financial regulation and oversight. While this financial pillar aimed at reconciling Europe’s historically bank-based financial systems with large European banks’ entry into global financial competition, it created a combustible mix when combined with the EMU’s macroeconomic-policy pillars. The Global Financial Crisis lit the fire: member-nations, forced to rescue their domestically-chartered too-big-to-fail megabanks, had to adopt austerity policies that both slowed the pace of post-crisis economic growth and eroded support for pro-Union political leaders. Only marginal changes have been made in these policy pillars post-crisis. Consequently, Europe faces a financial bifurcation point: either to continue ‘whatever it takes’ support for its megabanks, or to rethink both its financial architecture and its macroeconomic and financial policy pillars.

Niels Thygesen: An Academic in the Making of European Monetary Union

Niels Thygesen (born 1934) played for nearly five decades an influential role as a policy orientated academic, especially in the process of economic and monetary integration in Europe. He is especially known as a member of the Delors Committee and as the first Chair of the European Fiscal Board. As part of a re-search program on collecting memories, this paper publishes the results of several interviews with him. His early life offers insightful observations on the develop-ment of the economics profession in the postwar years (he was close to Nobel Prize laureates as Franco Modigliani and Milton Friedman). Thygesen's involvement with the process of European monetary integration really started in 1974 with his membership of the Marjolin Committee (which provided an assessment of the failure of the 1970 Werner Report). Since then he has been involved in a multitude of committees and initiatives, like the OPTICA groups, the All Saints Day Manifes-to, the Committee for Monetary Union in Europe (an initiative of Giscard and Schmidt) and the Euro50 Group.

The political economy of euro area sovereign debt restructuring

The establishment of a sovereign debt restructuring mechanism (SDRM) is one of the important issues in the academic debate on a viable constitution for the European Monetary Union (EMU). Yet the topic seems to be taboo in official reform contributions to the debate. Against this backdrop, the article identifies the SDRM interests of key players, including the European Commission, the European Parliament, the European Central Bank and national governments. The empirical section takes advantage of the recently established EMU Positions Database. The findings confirm political economy expectations: Low-debt countries support an EMU constitution that includes an insolvency procedure whereas a coalition of high-debt countries and European institutions oppose it. The analysis points towards a possible political-economic equilibrium for coping with sovereign insolvencies: an institutional set-up without an SDRM and with hidden transfers. Recent European fiscal innovations in response to the Covid-19 solvency shock confirm this prediction.

The Effects of Corruption in a Monetary Union

72% of Europeans in European Monetary Union countries think that corruption is widespread in their country. Corruption can affect the individual country’s performance and, in turn, impact on the performance of the other members of the monetary union. In this article, we will present a monetary union composed of two countries and we will study how the presence of corruption in one member country will affect its economy and the neighbour’s economy. Additionally, we will analyse what measures could reduce the negative spillover effects generated by the presence of corruption.

The ECB and the Cost of Independence. Unearthing a New Doom-Loop in the European Monetary Union

Central Bank Independence has often been praised as a “free lunch” as it lowers inflation with no costs to output. This paper, instead, claims that in a peculiar monetary union such as the European Monetary Union (EMU) defending the independence during a financial crisis can be macroeconomically costly: unconventional monetary policies may expose the European Central Bank (ECB) to the threat of fiscal dominance which, in turn, might endogenously shift the ECB’s fiscal stance toward fiscal conservatism. Fiscally hawkish signals can then depress GDP and inflation, thereby forcing the ECB to prolong the unconventional stimuli to achieve its target. This paper finds evidence of this new “doom-loop” at the core of the EMU.

Has the Euro Shrunk the Band? Relative Purchasing Power Parity Convergence in a Currency Union*

AbstractI study the effects of entry to the European Monetary Union (EMU) on relative purchasing power parity (PPP) convergence using monthly disaggregated price indices from 32 European countries from 1999 to 2016. I examine the entry of Cyprus, Malta, Slovakia, and Slovenia to the EMU, and I estimate the bands of inaction of relative prices before and after entry using a threshold autoregressive model. I find a positive effect of the EMU on relative PPP convergence: after entry, the bands of inaction with EMU members fell by 17 percent. Cross‐sectional evidence supports the theoretical prediction that bands of inaction are related to transaction costs.

The Political Economy of Euro Area Sovereign Debt Restructuring

The establishment of a sovereign debt restructuring mechanism (SDRM) is one of the important issues in the academic debate on a viable constitution for the European Monetary Union (EMU). Yet the topic seems to be taboo in official reform contributions to the debate. Against this backdrop, the article identifies the SDRM interests of key players, including the European Commission, the European Parliament, the European Central Bank and national governments. The empirical section takes advantage of the recently established EMU Positions Database. The findings confirm political economy expectations: Low-debt countries support an EMU constitution that includes an insolvency procedure whereas a coalition of high-debt countries and European institutions oppose it. The analysis points towards a possible political-economic equilibrium for coping with sovereign insolvencies: an institutional set-up without a SDRM and with hidden transfers. Recent European fiscal innovations in response to the Covid-19 solvency shock confirm this prediction.

Emu Deepening and Sovereign Debt Spreads: Using Political Space to Achieve Policy Space

Sovereign spreads within the European Monetary Union (EMU) arise because markets price-in heterogeneous country fundamentals, but also re-denomination risks, given the incomplete nature of EMU. This creates a permanent risk of financial fragmentation within the area. In this paper we claim that political decisions that signal commitment to safeguarding the adequate functioning of the euro area influence investors’ valuations. We focus on decisions conducive to enhancing the institutional framework of the euro area (“EMU deepening”). To test our hypothesis we build a comprehensive narrative of events (decisions) from all documents and press releases issued by the Council of the EU and the European Council during the period January 2010 to March 2020. We categorize the events as dealing with: (i) economic and financial integration; (ii) fiscal policy; (iii) bailouts. With our extremely rich narrative at hand, we conduct event-study regressions with daily data to assess the impact of events on sovereign bond yields and find that indeed decisions on financial integration drive down periphery spreads. Moreover, while decisions on key subjects present a robust effect, this is not the case with prior discussions on those subjects at the Council level. Finally, we show that the impacts arise from reductions in peripheral sovereign spreads, and not by the opposite movement in core countries. We conclude that EU policy-makers have at their disposal significant “political space” to reduce fragmentation and gain “policy space”.

Common Currency Area in GCC Region: An Application of Euro Model

US Dollar (USD) is the most dominant currency encompassing 59.54% of the world reserve currency. Euro is the second one, which holds 20.57% share of world reserve currency. The recent studies reveal that the USD might not be the dominant world reserve currency in the future. Euro as a common regional currency is the only competitor of USD, which shows the strength of a unified regional currency. In 1981, the six rich oil states formed Gulf Cooperative Council (GCC); the countries include the Kingdom of Saudi Arabia, the State of Qatar, the Sultanate of Oman, the Kingdom of Bahrain, the State of Kuwait, and the United Arab Emirates. This establishment of GCC signifies the close cultural, economic and political link between the GCC countries. GCC countries have almost all essential ingredients required to establish a common currency area or monetary union. The researcher applied the European Monetary Union (EMU) model to GCC states to find out the feasibility of a common currency or monetary union between GCC states. Currently, EMU is the only example of successful implementation of common regional currency founded on Mundell’s theory of Optimum Currency Area (OCA). The results obtained indicate that all the GCC states successfully fulfill the Euro criteria which are also called Maastricht criteria. The research has established that GCC countries are ripe for establishing a monetary union, especially if they follow the steps of EMU.

On Optimal Currency Areas and Common Cycles: Are the Acceding Countries Ready to Join the Euro?

The former EU president Jean-Claude Junker has proposed that all countries of the European Union should also adopt the euro as their currency and recent research has shown that countries currently pursuing this goal indeed fulfill the classical Optimal Currency Area (OCA) criterion of positively correlated shocks with the European Monetary Union (EMU). We illustrate, however, that not only the correlation of shocks but also a common impulse response pattern over time is needed for a currency area to be optimal. We test this additional OCA criterion using the concept of a common serial correlation test. The test clearly rejects the notion that the potentially acceding countries share a common cyclical response pattern with the EMU aggregate – except for Sweden. Instead, the business cycles in most of the other countries exhibit only a very weak form of codependence.

Цели региональной интеграции: современное понимание

To date, an extensive scholarly literature on regional integration has paid little attention to the question of its goals. However, it is fundamental for deeper understanding the nature of the phenomena and for the decision-making process at the national, regional and international levels. The objective of this article is to reveal declared and de facto pursued goals of regional integration, and to arrange them into a coherent system. To accomplish this task this paper first provides an overview of official goals stated in the founding agreements of various regional groups, formed by developed and developing countries in Europe, Asia and Americas. Then the question of goals is explored through the lenses of the key theories of regional economic integration and their practical application. Later a similar exercise is carried out in the context of political integration theories. Finally, based on the comprehensive analysis of official declarations, major theories of regional integration and practical developments in various regions and policy fields this paper categorizes main goals of regional integration into four groups compiled along two axes: internal and external, positive and negative. They form a matrix, which endows researchers with new optics. Further exploration of different types of integration goals, especially negatively oriented ones, has a potential to expand the research program of integration studies. They may also shed light on the debate over why regional blocks of developing countries stall at the level of free trade zones or why the creation of the European monetary union did not help the EU to move to the true political union.

The Euro @ 20: How Economic and Financial “Asymmetries” Marred the Promise of the Single Currency

The launch of the single currency in 1999 rekindled the European Union's momentum toward deeper integration. And yet progress during its first decade of low interest rates was undermined by bulging budgetary and current account deficits in several eurozone sovereigns that brought them to the brink of default in 2010. The second decade of sluggish and lopsided recovery since then has deeply scarred Europe's social fabric and widened the divide between the single currency's winners (Northern European nations) and losers (Mediterranean countries).This article provides a retrospective, cast in the form of a play in five acts, of the EU's protracted quest for monetary union that begins by explaining how the euro crisis was seeded. In Act I the authors recount the quest for a European Monetary Union and document the gradual deepening of monetary cooperation among member states. The launch of the euro in 1999, as presented in Act II, held out promise for the single currency, but was later broken by a euro crisis that is viewed (in Act III) through the lens of the optimal currency area construct. The likely future of the euro, now in its 20th year, is projected in Act IV in terms of a “muddling through” scenario. Act V closes by providing a view of two other possibilities issuing from the pandemic—one that leads to a splintering of the European monetary union, and the other to the passage of bold reforms that end up strengthening the union.