Unified Currency Research Articles

Monetary Policy in Unified Currency Areas: The Cases of the Cama and Ecca During 1976-90

Monetary Policy in Unified Currency Areas: The Cases of the Cama and Ecca During 1976-90

Monetary Policy in Unified Currency Areas: The Cases of the Cama and Ecca During 1976-90

The paper compares the performance of monetary policy in the Central African Monetary Area (CAMA) and the Eastern Caribbean Currency Area (ECCA) during 1976-90. Their institutional setup and mechanism for monetary control are examined to explain the opposite trends in the net external position of their banking system during this period. It concludes that monetary policy in the ECCA succeeded by relying on active interest rate management aimed at stemming capital outflows and adhering to stringent rules aimed at limiting credit expansion. The passive policy stance in the CAMA contributed to a significant redistribution of the area’s money stock.

Testing the Monetary Approach to Devaluation in Developing Countries

The monetary approach to the balance of payments suggests that surpluses and deficits are essentially adjustment phenomena which serve to equilibrate the money stock in existence to the quantity demanded in an open economy. An increase in the domestic money supply via increased domestic credit creation, by either central or private banks, leads to larger deficits which, in turn, deplete the excess supply of money. A devaluation, however, raises domestic prices and as a result increases the demand for money, thereby leading to a temporary improvement in the balance of payments. 1 The purpose of this paper is to test the monetary approach to devaluation from a sample of 18 independent devaluations that took place in developing countries during the 1959-70 period and, at the same time, to indicate the conditions under which devaluation is successful in improving the balance of payments. In the process, the paper sheds light on two important related issues: first, the degree to which devaluation is inflationary per se, and second, the extent to which devaluation changes the price of traded goods relative to nontraded ones. Part I sets out a simple monetary model appropriate for empirical testing of the monetary approach, Part II summarizes the results of the empirical tests, and Part III focuses upon the impact of devaluation upon the terms of trade and domestic prices. The concluding section discusses Richard Cooper's (1971) test of the monetary approach and attempts to assess the weaknesses and strengths of the monetary framework.

The future of the international monetary system

So much has been written and is currently being written on the future of the international monetary system, that it is impossible to read everything and to say anything new. Moreover things are changing all the time, often very fast and unexpectedly, so that what one says today may appear to be out of date tomorrow. In such a situation it is, I believe, a good idea to go back to fundamental principles which are often lost sight of, although they often are a safer guide for things to come than the extrapolation of recent trends. Let me start from a proposition on which in my opinion most economists, advocates of floating as well as of fixed or "stable but adjustable" exchange rates could agree: The ideal international monetary arrangement would be permanently fixed exchange rates with fully convertible currencies (no controls) and preferably no margin, provided the system does not impose too much inflation or deflation (unemployment) on any country. This is the arrangement which we have inside each country including the largest. Nobody, not even the most radical floater, has recommended that the United States should be split up into different currency areas. I need not take time to explain the immense advantage which the U. S. economy derives from having a unified currency, because that has been done many times by advocates of fixed exchange rates, such as Charles Kindleberger and Robert M und ell as well as by some floaters such as Allan Meitzer. Naturally the smaller a country the more important a stable exchange rate and very small countries, Liechtenstein, Monaco but even Luxemburg have virtually no choice but to link up rigidly with the currency of a large neighbor.

Uncertainty, Currency Areas and the Exchange Rate System

The uniqueness of international finance reflects the multitude of national currencies. Both benefits and costs are attached to separate national currencies. Each country with its own currency can pursue an independent monetary policy. Various costs are incurred with the foreign transactions associated with international payments. These costs are avoided in a unified currency world, since there is no exchange market, but the advantages of independent monetary policies are not attained. The trade-off between the advantages of independent monetary policies and the costs of exchange markets involves optimization, both of the number and scope of national currency areas and also (of greater immediacy) in the type of exchange rate system-the choice between pegged rates and floating rates and among various types of pegged systems. The frequent exchange crises in recent years have indicated that the International Monetary Fund system of adjustable pegs has not been functioning well. National authorities have been reluctant to change the parities; variations in ad hoc controls on foreign payments have compensated for sticky exchange pegs. These controls constitute selective changes in exchange rates, so that a system of multiple exchange rates has resulted. The rationale for the commercial policy approach to international adjustment is that the political costs associated with changes in the exchange rate are avoided. Floating exchange rates are sometimes viewed as a way to attain greater flexibility and yet avoid the political costs associated with changes in parities. Other proposals for increased flexibility seek to retain elements of the pegged system so as to minimize uncertainty in the exchange market and the likelihood of disorderly national behaviour in it. The proposals for wider support limits, crawling pegs and sliding bands differ in terms of the frequency and method by which the parity is changed and the width of the support limits around the parity.' This paper identifies economic criteria which provide a basis for

Capital Markets and the Unification of Europe

The expectation that a customs union in Europe will ultimately lead to political unification is based on the so-called spillover effect. This effect operates whenever any step toward integration creates new needs and fresh demands to proceed further in the same direction. Thus a customs union may create pressures to integrate not only commodity markets but capital markets as well. An integration of capital markets in turn may necessitate currency unification for its effective functioning, and a unified currency finally may imply a pooling of sovereignties sufficiently complete to destroy the separate identities of the participating nation-states. The process could also work in the opposite direction: from an insistence on the integrity of the nation-state to an ultimate rejection of the customs union itself.

Professor James on the theory of monetary policy

strongest financial powers of the free world; and only if France uses its strength so as to foster rather than to impede monetary cooperation, in domestic as well as international matters, can the world economy be expected to grow in the future at the same rapid pace and with the same absence of serious interruptions as it has done in the recent past, since the institution of the Marshall Plan. For that reason, French monetary policy, and with it the theoretical framework that conditions and explains its practice, are vital elements in today's and tomorrow's economic life. Professor James shows his mastery of the subject, and a remarkable knowledge not only of European but also of American literature2. In particular, he asks the correct fundamental question: What are the conditions and the limits of the influence of monetary developments on the economy (page 42)? And he correctly defines the goal of monetary policy not just as monetary equilibrium (as usual in Continental Europe) but as "the most rapid pace of growth compatible with monetary equilibrium" (page 197). In his analysis, Professor James mentions the concept of "domination" (page 147), introduced into economic theory by Professor Per roux but sadly neglected, at least in American literature. That concept might well be used more extensively in explanation of the differences between the functions of a key currency and a peripheral currency, and the problems confronting them. Professor James sketches the development of monetary theory from the times of Wicksell and Schumpeter to the present (pages 746 and 116 to 148); explains demand for and supply of money, monetary equilibrium, and disequilibrium in its inflationary form (pages 47-115 and 149-187); discusses the principles of domestic and international monetary policy (pages 189-297); and briefly mentions French monetary policy in the period 1958-1963 (pages 299-312), international liquidity and reform of the International Monetary Fund (pages 312-333), and the attempts at creating a unified European currency (pages 334-344).