Download Monetary Intergration

Monetary Integration
By:
Jia Ling
Royce Yu
Econ-515
Spring 2005
Monetary Integration

What is MI ?
• the transition from multiple currencies
to one currency.
• coordination of monetary policies of
multi-currencies for monetary stability.

Why nations need MI?
• to avoid vulnerability and instability of
multiple currencies.
How to Do MI

Surrender’s approach
• dolarization (market).

Government mandate
• unification(shock therapy).

Partner’s approach
• agreements(institutional approach).
Theory about MI(1)

Fixed exchange rate system
• gold standard, US dollar system.

Flexible exchange rate system
• pegged, band, crawling.

Floating rate
• market driven.
Theory about MI(2)

Optimum Currency Areas
• rooted in Keynesian tradition.
• assumptions: price level and wage level of an
economy are rigid.
• besides flexible rate: alternative? How effective
compared with flexible rate?
• three criterions to exam:


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the degree of factor mobility.
the degree of openness.
the degree of coordination of fiscal policies.
Theory about MI (3)

OCA:
• In areas where exist symmetric
incidence of shocks and real wage rate
flexibility as well as mobility of labor, an
optimum currency area can be formed
so as to gain better efficiency of
transaction and welfare benefit than an
exchange rate flexibility can offer
(Mundell, 1961).
Theory about MI (4)

The father of the Theory
of OCAs:
• Professor Robert Mundell.
• 1999 Nobel Laureate.
• He initiated it in 1961.
Theory about MI (5)

Self_Validating OCA (two equilibria identified)
• in the first equilibrium local pricing; foreign price
determined by the Law of One Price. Optimal policy rules
then target the domestic output gap and floating
exchange rates support the flex-price allocation.
• in the second equilibrium local pricing; a monetary union
is the optimal policy choice for all countries.

Benefit:Although business cycles more
synchronized with a common currency, flexible
exchange rates are superior in terms of welfare.
Past efforts of MI

1979-1999 from US dollar system to
MI
• An exercise of political economy.
• Three alternative ways:



market approach (Panama).
institutional approach (EU).
a shock therapy (Germany,1989-1990).
Present issues




Policies tied to low-inflation target
(2.8%).
Policies constrained by the pursuit of
a balanced-budget.
Cost of time consuming coordinations
and complex procedures.
Uneven political and economic
commitment: balancing for growth
and gain.
Future Issues

Expansion
• drive neighboring countries to feel
pressured to join in.
• to counteract divergences: labor
mobility.


Deeper integration: financial market
and political coordination.
The journey has just started.
Pros




Lowers transaction costs
Reduce uncertainties
Ends currency instability in the
participating countries
Lowers interest rates
Cons



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Loss of some macro policy
independence.
Loss of some national sovereignty
Introduction cost
Loss of some seigniorage
Requirements
Based on Maastricht Treaty in
Dec.1991
Inflation
<1.5%
higher
L.T. interest Devaluarate
tion
<2% higher
Budget
deficit
Not present <3% of its
in the
GDP
previous
years
Debt
<60% of its
GDP