nep-mon New Economics Papers
on Monetary Economics
Issue of 2012‒02‒27
twenty-six papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Can the Fed talk the Hind Legs off the Stock Market? (replaces CentER DP 2011-072) By Eijffinger, S.C.W.; Mahieu, R.J.; Raes, L.B.D.
  2. Did the Fed and ECB react asymmetrically with respect to asset market developments? By Hoffmann, Andreas
  3. ECB Policy Response to the Euro/US Dollar Exchange Rate By Demir, Ishak
  4. The dollar squeeze of the financial crisis. By Jean-Marc Bottazzi; Jaime Luque; Mário R. Páscoa; Suresh Sundaresan
  5. Public Debt, Distortionary Taxation, and Monetary Policy By Alessandro Piergallini; Giorgio Rodano
  6. The effects of monetary policy shocks in credit and labor markets with search and matching frictions By Giuseppe Ciccarone; Francesco Giuli; Danilo Liberati
  7. Two Exercises of Inflation Modelling and Forecasting for Azerbaijan By Alexander Chubrik; Przemyslaw Wozniak; Gulnar Hajiyeva
  8. The Risk-Taking Channel in Colombia Revisited By Martha López; Fernando Tenjo; Héctor Zárate
  9. Money and monetary system in China in the 19th-20th century: an overview By Ma, Debin
  10. The relationship between the objectives and tools of macroprudential and monetary policy By David Green
  11. Search and endogenous growth: when Romer meets Lagos and Wright By Chu, Angus C.; Lai, Ching-Chong; Liao, Chih-Hsing
  12. The relationship between central bank transparency and the quality of inflation forecasts: is it U-shaped? By Emna Trabelsi
  13. Lessons of the European Crisis for Regional Monetary and Financial Integration in East Asia By Volz, Ulrich
  14. Forecasting inflation in Asian economies By Liew, Freddy
  15. Determinants of carry trades in Central and Eastern Europe By Hoffmann, Andreas
  16. Regional and Global Monetary Cooperation By Lamberte, Mario; Morgan , Peter J.
  17. De facto currency baskets of China and East Asian economies: The rising weights By Fang, Ying; Huang, Shicheng; Niu, Linlin
  18. A Fiscal Stimulus with Deep Habits and Optimal Monetary Policy By Cristiano Cantore; Paul Levine; Giovanni Melina; Bo Yang
  19. Efficiency of monetary and fiscal policy in open economies By Chan Wang; Heng-fu Zou
  20. Using Survey Data on Inflation Expectations in the Estimation of Learning and Rational Expectations Models By Ormeño, Arturo
  21. Monetary Policy and Stock-Price Dynamics in a DSGE Framework By Salvatore Nisticò
  22. The Political Economy of European Monetary Union By A. R. Nobay
  23. Optimal Monetary Policy and Stock-Prices Dynamics in a Non-Ricardian DSGE Model By Salvatore Nistico'
  24. Central Banking for the 21st Century: An American Perspective By Paul Wachtel
  25. The case for higher frequency inflation expectations By Guzman, Giselle C.
  26. Euro Zone Crisis and EU Governance: Tackling a Flawed Design and Inadequate Policy Arrangements By Daniel Daianu

  1. By: Eijffinger, S.C.W.; Mahieu, R.J.; Raes, L.B.D. (Tilburg University, Center for Economic Research)
    Abstract: Abstract: Central banks in fluence financial markets' expectations of its future policy. By providing its stance on the prospects of the economy, rationalizing past decisions or announcing future actions, central banks affect financial markets' forecasts. In bad times monetary policy communication inducing an upward revision of the path of future policy is good news for stocks. During an expansion the effect is weak and on average negative. The response of equities to central bank talk depends critically on the business cycle. There are strong industry specific effects of monetary policy actions and communication. These industry effects relate to the variation in cyclicality of different industries. Firmspecific effects of monetary policy relate to the leverage, the size and the price-earnings ratio of firms.
    Keywords: Monetary policy;Federal Reserve Communication;Credit channel;Business cycle;Stock market.
    JEL: G14 E44 E52 E58
    Date: 2012
  2. By: Hoffmann, Andreas
    Abstract: This paper studies the monetary policy of the Federal Reserve (Fed) and the Bundesbank / European Central Bank (ECB) with respect to stock or/and foreign exchange markets from 1979 to 2009. I find that Fed policy changed over time, dependent on the chairman of the Fed. During the Greenspan era stock markets mattered for the Fed. In this period, the Fed lowered interest rates when stock prices fell, but did not raise interest rates in the boom. This asymmetry potentially put a downward pressure on interest rates. For the ECB, the exchange rate to the dollar played a role in monetary policy decisions until 2006. While I do not find evidence of asymmetric monetary policy with respect to the stock market, the ECB may be argued to indirectly have followed asymmetric US monetary policy via the exchange rate channel. --
    Keywords: monetary policy,Taylor rule,asset prices
    JEL: E52 E61
    Date: 2012
  3. By: Demir, Ishak
    Abstract: The exchange rate is an important part of transmission mechanism in the determination of monetary policy because movements in the exchange rate have significant effect on the macroeconomy. Measuring the reaction of monetary policy to the movements in exchange rate has some difficulties due to the simultaneous response of monetary policy on the exchange rate and the possibility that both variables respond several other variables. This study will use an identification method based on the heteroscedasticity in the high-frequency data. In particular, shifts in the importance of exchange rate relative to monetary policy shocks, and the estimated changes in the covariance between the shocks that result, allow us to measure the reaction of interest rates to changes in exchange rates. This study comes up with unbiased estimates with heteroscedasticity based identification approach and results of this paper suggest that ECB systematically respond to the exchange rate movements but that quantitative effects are small. The empirical results indicate that a 1 point rise (fall) in the exchange rate tends to decrease (increase) the three-month interest rate by around 20 basis points. Small and negative reaction coefficient implies that ECB may respond to the movements in exchange rate only to the extent warranted by their impact on the macroeconomy, since it affects the expected inflation and future output path.
    Keywords: Monetary Policy; Exchange Rates; Identi…cation through Heteroscedasticity; European Central Bank; Monetary Policy Reaction
    JEL: G12 E58 E5 E52 E44 E40
    Date: 2012–02–17
  4. By: Jean-Marc Bottazzi (Centre d'Economie de la Sorbonne - Paris School of Economics); Jaime Luque (Universidad Carlos III de Madrid); Mário R. Páscoa (NOVA - Business School of Economics and Finance); Suresh Sundaresan (Columbia University)
    Abstract: By Covered Interest rate Parity (CIP), the FX swap implied currency interest rates should coincide with actual interest rates. When a difference occurs, the residual is referred to as the cross currency basis. We link the Euro-Dollar currency basis (e.g. in 2008) to shadow prices of dollar funding constraints and interpret the basis as the relative physical possession value of the scarcer currency, or the "convenience yield" associated with that currency. This is similar to specialness in repro markets, expressing the physical possession value of a security. We examine how the coordinated central banks intervention can reduce the currency basis.
    Keywords: FX swaps, repo, Euro-Dollar currency basis, the 2008 dollar squeeze, possession.
    JEL: D52 D53 G12 G14 G15 G18
    Date: 2012–02
  5. By: Alessandro Piergallini (Faculty of Economics, University of Rome "Tor Vergata"); Giorgio Rodano (University of Rome “La Sapienza”)
    Abstract: Since Leeper’s (1991, Journal of Monetary Economics 27, 129-147) seminal paper, an extensive literature has argued that if fiscal policy is passive, i.e., guarantees public debt stabilization irrespectively of the inflation path, monetary policy can independently be committed to inflation targeting. This can be pursued by following the Taylor principle, i.e., responding to upward perturbations in inflation with a more than one-for-one increase in the nominal interest rate. This paper analyzes an optimizing framework in which the government can only finance public expenditures by levying distortionary taxes. It is demonstrated that households’ market participation constraints and Laffer-type effects can render passive fiscal policies unfeasible. For any given target inflation rate, there exists a threshold level of public debt beyond which monetary policy independence is no longer possible. In such circumstances, the dynamics of public debt can be controlled only by means of higher inflation tax revenues: inflation dynamics in line with the fiscal theory of the price level must take place in order for macroeconomic stability to be guaranteed. Otherwise, to preserve inflation control around the steady state by following the Taylor principle, monetary policy must target a higher inflation rate.
    Keywords: Public Debt; Distortionary Taxation; Monetary and Fiscal Policy Rules.
    JEL: E63 H31 H63
    Date: 2012–02–07
  6. By: Giuseppe Ciccarone; Francesco Giuli; Danilo Liberati
    Abstract: By introducing search and matching frictions in both the labor and the credit markets into a cash in advance New Keynesian DSGE model, we provide a novel explanation of the incomplete pass-through from policy rates to loan rates. We show that this phenomenon is ineradicable if banks possess some power in the bargaining over the loan rate of interest, if the cost of posting job vacancies is positive and if firms and bank sustain costs when searching for lines of credit and when posting credit vacancies, respectively. We also show that the presence of credit market frictions moderates the reactions of output and wages to a monetary shock, and that the transmission of monetary policy shocks to output and inflation is more relevant than suggested by the recent literature.
    Keywords: interest rate pass-through,search and matching, credit market frictions.
    JEL: E43 E13 E24 E44
    Date: 2012–01
  7. By: Alexander Chubrik; Przemyslaw Wozniak; Gulnar Hajiyeva
    Abstract: The paper proposes two econometric models of inflation for Azerbaijan: one based on monthly data and eclectic, another based on quarterly data and takes into account disequilibrium at the money market. Inflation regression based on monthly data showed that consumer prices dynamics is explained by money growth (the more money, the higher the inflation), exchange rate behaviour (appreciation drives disinflation), commodities price dynamics (“imported” inflation) and administrative changes in regulated prices. For the quarterly model, nominal money demand equation (with inflation, real non-oil GDP and nominal interest rate on foreign currency deposits as predictors) and money supply equation were estimated, and error-correction mechanism from money demand equation was included into inflation equation. It is shown that disequilibrium at the money market (supply higher than demand) drives inflation together with money supply growth and nominal exchange rate depreciation and administrative changes in prices. No cost-push variables appeared to be significant in this equation specification. Both models give similar inflation projections, but sudden changes in money demand (2012) lead to significant differences between the projections. It is shown that money is the most important inflation determinant that explains up to 97.8% of CPI growth between 2012 and 2015, and that in order to keep inflation under control the Central Bank of Azerbaijan should link money supply to real non-oil GDP growth.
    Keywords: Inflation modelling, Inflation forecasting, Money demand, Money supply, Azerbaijan
    JEL: C32 E31 E41 O52
    Date: 2012
  8. By: Martha López; Fernando Tenjo; Héctor Zárate
    Abstract: Levels of interest rates below historical norms may have enhanced financial instability in developed and developing economies during the 2000's. The risk taking channel of monetary policy transmission is a recent theory that explains the interaction between risk perceptions of the financial system and monetary policy. This paper presents empirical evidence of the risk taking channel of monetary policy using detailed information on consumer and commercial loans from the Colombian banking system. Using probit and duration models we find that the banking system takes on more risk when the level of interest rates are too low. We also find that the response to interest rates is higher in the case of commercial loans.
    Date: 2012–02–07
  9. By: Ma, Debin
    Abstract: This article provides an historical overview on the development of Chinese money and monetary regimes between about 1800 and 1950. It develops a simple conceptual framework based on the relative costs of assessing the inherent value of the currencies of different denomination. Based on this framework, I develop a historical narrative that ties important political and institutional changes with the evolving structural changes in the Chinese monetary regime marked by the vicissitudes in the use of copper, silver currencies and paper money in both the private and public financial sectors from the Opium War in mid-19th century to the end of the Civil War in the 1950s.
    JEL: O53 N0
    Date: 2012–01
  10. By: David Green
    Abstract: No Abstract is available.
    Date: 2011–05
  11. By: Chu, Angus C.; Lai, Ching-Chong; Liao, Chih-Hsing
    Abstract: In this note, we develop a search-based monetary growth model to analyze the growth and welfare effects of inflation. We introduce endogenous growth via capital externality into a two-sector search model and compare the effects of inflation to those from a standard cash-in-advance (CIA) growth model. We …find two important differences between the two approaches. First, while the growth effect of inflation operates solely through endogenous labor supply in the CIA model, the growth effect of inflation operates through an additional consumption effect in the decentralized market in the search model. Second, we quantitatively evaluate the welfare cost of inflation and fi…nd that the search model exhibits a larger (smaller) welfare gain than the CIA model when we decrease the growth rate of money supply to achieve the Friedman rule (zero inflation). These contrasting results are due to a non-linearity in welfare as a function of inflation in the search model.
    Keywords: economic growth; inflation; monetary policy
    JEL: O42 O41 E41
    Date: 2012–02
  12. By: Emna Trabelsi
    Abstract: A recent theoretical literature highlighted the potential dangers of further increasing information disclosure by central banks. This paper gives a continuous empirical investigation of the existence of an optimal degree of transparency in the lines of van der Cruijsen et al. We test a quadratic relationship between central bank transparency and the inflation persistence by introducing some technical and economic modifications. Particularly, we used three new measures of transparency. An appropriate U shape test that was made through a Stata routine, recently developed by Lind and Mehlum, indicates a robust optimal intermediate degree of transparency, but its level is not. These results were obtained using a panel of 11 OECD central banks under the period 1999-2009. The estimations were run using a bias corrected LSDVC, a newly recent technique developed by Bruno for short dynamic panels with fixed effects, extended to accommodate unbalanced data.
    Keywords: Intermediate optimal transparency degree, inflation forecasts, inflation persistence, u-shaped relationship, non linear modeling, LSDVC, Principal Component Analysis.
    JEL: C23 E58
    Date: 2012–01–02
  13. By: Volz, Ulrich (Asian Development Bank Institute)
    Abstract: The debt crisis in several member states of the euro area has raised doubts on the viability of European Economic and Monetary Union (EMU) and the future of the euro. While the launch of the euro in 1999 stirred a lot of interest in regional monetary integration and even monetary unification in various parts of the world, including East Asia, the current crisis has had the opposite effect, even raising expectations of a break-up of the euro area. Indeed, the crisis has highlighted the problems and tensions that will inevitably arise within a monetary union when imbalances build up and become unsustainable. This note discusses the causes of the current European crisis and the challenges that EMU countries face in solving it. Based on this analysis, it derives five lessons for regional financial and monetary cooperation and integration in East Asia.
    Keywords: european crisis; euro area; european monetary union; financial integration; east asia
    JEL: E42 F33 F36 G01
    Date: 2012–02–23
  14. By: Liew, Freddy
    Abstract: This paper surveys the recent literature on inflation forecasting and conducts an extensive empirical analysis on forecasting inflation in Singapore, Japan, South Korea and Hong Kong paying particular attention to whether the inflation-markup theory can help to forecast inflation. We first review the relative performance of different predictors in forecasting h-quarter ahead inflation using single equations. These models include the autoregressive model and bivariate Philips curve models. The predictors are selected from business activity, financial activity, trade activity, labour market, interest rate market, money market, exchange rate market and global commodity market variables. We then evaluate a vector autoregressive inflation-markup model against the single equation models to understand whether there is any gain in forecasting using the inflation-markup theory. The paper subsequently analyses the robustness of these results by examining different forecasting procedures in the presence of structural breaks. Empirical results suggest that inflation in Singapore, Hong Kong and South Korea is best predicted by financial and business activity variables. For Japan, global commodity variables provide the most predictive content for inflation. In general, monetary variables tend to perform poorly. These results hold even when structural break is taken into consideration. The vector autoregressive inflation-markup model does improve on single equation models as forecasting horizon increases and these gains are found to be significant for Japan and Korea.
    Keywords: Inflation; Markup; Forecasting; Asia; Structural Break
    JEL: C32 C53 E31
    Date: 2012–01–01
  15. By: Hoffmann, Andreas
    Abstract: In this paper, I analyze determinants of carry trade returns in Central and Eastern Europe (CEE). I show that carry trades to CEE were lucrative due to interest rate spreads between the funding and investment currency from 2004 to 2006. They became unprofitable when liquidity risk and exchange rate volatility increased after 2007. The analysis suggests that the exchange rate regime of the CEE economy matters for carry trade returns. Overall, exchange rate stabilization, particularly via managed floats, seems to allow for the highest profit opportunities. --
    Keywords: carry trades,emerging markets,exchange rates
    JEL: E32 E44 F31 G11
    Date: 2011
  16. By: Lamberte, Mario (Asian Development Bank Institute); Morgan , Peter J. (Asian Development Bank Institute)
    Abstract: The increasing occurrence of national, regional, and global financial crises, together with their rising costs and complexity, have increased calls for greater regional and global monetary cooperation. This is particularly necessary in light of volatile capital flow movements that can quickly transmit crisis developments in individual countries to other countries around the world. Global financial safety nets (GFSNs) are one important area for monetary cooperation. This paper reviews the current situation of regional and global monetary cooperation, focusing on financial safety nets, with a view toward developing recommendations for more effective cooperation, especially between the International Monetary Fund (IMF) and regional financial arrangements (RFAs).
    Keywords: monetary cooperation; regional monetary cooperation; global monetary cooperation; regional financial arrangements; financial safety nets; global financial crises
    JEL: F33 F34 F36 F53 F55
    Date: 2012–02–23
  17. By: Fang, Ying (BOFIT); Huang, Shicheng (BOFIT); Niu, Linlin (BOFIT)
    Abstract: We employ Bayesian method to estimate a time-varying coefficient version of the de facto currency basket model of Frankel and Wei (2007) for the RMB of China, using daily data from February 2005 to July 2011. We estimate jointly the implicit time-varying weights of all 11 currencies in the reference basket announced by the Chinese government. We find the dollar weight has been reduced and sometimes significantly smaller than one, but there is no evidence of systematic operation of a currency basket with discernable pattern of significant weights on other currencies. During specific periods, the reduced dollar weight has not been switched to other major international currencies, but to some East Asian currencies, which is hard to explain by trade importance to or trade competition with China. We examine currency baskets of these East Asian Economies, including major international currencies and the RMB in their baskets. We find an evident tendency of Malaysia and Singapore to increase the weights of RMB in their own currency baskets, and a steadily and significantly positive weight of RMB in the basket of Thailand. These evidences suggest that, the positive weights of some East Asian currencies in RMB currency basket during specific periods largely reflect the fact that these East Asia economies have been systematically placing greater weights on RMB under the new regime of RMB exchange rate.
    Keywords: RMB currency basket; time-varying regressions; East Asia; China; US
    JEL: C11 F31 F41
    Date: 2012–02–23
  18. By: Cristiano Cantore (University of Surrey); Paul Levine (University of Surrey); Giovanni Melina (University of Surrey); Bo Yang (University of Surrey)
    Abstract: A New-Keynesian model with deep habits and optimal monetary policy delivers a fiscal multiplier above one and the crowding-in effect on private consumption obtainable in a Real Business Cycle model à la Ravn et al. (2006). Optimized Taylor-type or price-level interest rate rules yield results close to optimal policy and dominate a conventional Taylor interest rate rule. Private consumption is crowded out only if the Taylor rule is sub-optimal and then negates the fiscal stimulus by responding strongly to the output gap, or if the ability to commit is absent. At the zero lower bound private consumption is always crowded in across simple rules.
    Keywords: Deep habits, Optimal monetary policy, Price-level rule, Zero lower bound
    JEL: E30 E62
    Date: 2012–02
  19. By: Chan Wang (CEMA, Central University of Finance and Economics); Heng-fu Zou (CEMA, Central University of Finance and Economics)
    Abstract: This paper investigates the efficiency of monetary and fiscal policy in two-country general equilibrium model with monopolistic competition and price stickiness. Comparing the efficiency of global monetary policy that replicates the real allocations with flexible wages before and after introducing stochastic government spending, we conclude that stochastic government spending is vital, the global monetary policy replicating the real allocations with flexible wages will turn from being efficient to being inefficient when some conditions are satisfied. When the stochastic government spending is present, we also find that the monopoly distortions are essential for the efficiency of the global monetary policy that replicates the real allocations with flexible wages. Complete removal of the monopoly distortions will cause the efficient global monetary policy replicating the real allocations with flexible wages to be inefficient when some conditions are satisfied. Fiscal policy is found to be unable to replicate the real allocations with flexible wages.
    Keywords: New open-economy macroeconomics, Efficiency of monetary policy, Stochastic government spending, Monopoly distortions
    Date: 2012–02–13
  20. By: Ormeño, Arturo (Department of Economics, University of Amsterdam (UvA))
    Abstract: Do survey data on inflation expectations contain useful information for estimating macroeconomic models? I address this question by using survey data in the New Keynesian model by Smets and Wouters (2007) to estimate and compare its performance when solved under the assumptions of Rational Expectations and learning. This information serves as an additional moment restriction and helps to determine the forecasting model for inflation that agents use under learning. My results reveal that the predictive power of this model is improved when using both survey data and an admissible learning rule for the formation of inflation expectations.
    Keywords: Survey data; Learning models; Inflation expectations; Bayesian econometrics
    JEL: C11 D84 E30 E52
    Date: 2012–02
  21. By: Salvatore Nisticò (Università degli Studi di Roma “La Sapienza" and LUISS Guido Carli)
    Abstract: This paper analyzes the role of stock prices in driving Monetary Policy for price stability in a Non-Ricardian DSGE model. It shows that the dynamics of the interest rate consistent with price stability requires a response to stock-price changes that depends on the shock driving them: a supply shock (e.g. productivity) does not require an additional, dedicated response relative to the standard Representative-Agent framework, while a demand shock does. Moreover, we show that implementing the exible-price allocation by means of an interest-rate rule that reacts to deviations of the stock-price level from the exible-price equilibrium incurs risks of endogenous instability that are the higher the less profitable on average equity shares. On the other hand, reacting to the stock-price growth rate is risk-free from the perspective of equilibrium determinacy, and can be beneficial from an overall real stability perspective.
    Keywords: Monetary Policy, DSGE Models, Stock Prices, Wealth Effects.
    JEL: E12 E44 E52
    Date: 2012–02–10
  22. By: A. R. Nobay
    Abstract: Issues of European monetary union and international commercial policy share the centre stage of very current deliberations. This paper addresses the broader political economy perspective of monetary union rather than the specifics of this or that proposal, so as to abstract from the somewhat fluid nature of the discussions. I consider in turn, the background to the quest for monetary union, the conventional economic wisdom of such issues and finally, and more speculatively, the political economy aspects of European monetary arrangements in the world economy.
    Date: 2011–12
  23. By: Salvatore Nistico' (University of Rome La Sapienza and LUISS Guido Carli University)
    Abstract: In a DSGE model with non-ricardian agents, a' la Blanchard-Yaari, stock-price fluctuations affect the dynamics of aggregate consumption through wealth effects. This wealth effects can be characterized as an additional dynamic distortion with respect to the social planner allocation, related to the cross sectional consumption dispersion that the decentralized allocation implies. By exploiting the specific cross-sectional distribution that the model implies for individual financial wealth, this paper derives the welfare criterion consistent with this economy, and shows that it features an additional target besides output-gap and price stability: financial stability. The ultimate implication is that price stability is no longer necessarily optimal, even absent cost push shocks. Given the quadratic form of the welfare criterion, some fluctuations in output and inflation will be optimal as long as they reduce the volatility of financial wealth.
    Keywords: Monetary Policy, DSGE Models, Stock Prices, Wealth Effects.
    JEL: E12 E44 E52
    Date: 2011
  24. By: Paul Wachtel
    Date: 2011
  25. By: Guzman, Giselle C.
    Abstract: I present evidence that higher frequency measures of inflation expectations outperform lower frequency measures of inflation expectations in tests of accuracy, predictive power, and rationality. For decades, the academic literature has focused on three survey measures of expected inflation: the Livingston Survey, the Survey of Professional Forecasters, and the Michigan Surveys of Consumers. While these measures have been useful in developing models of forecasting inflation, the data are low frequency measures that are anachronistic in the modern era of high frequency and real-time data. I present a collection of 37 different measures of inflation expectations, including many previously unexploited monthly and real-time measures of inflation expectations. These higher frequency measures tend to outperform the standard three low frequency survey measures in tests of accuracy, predictive power, and rationality, indicating that there are benefits to using higher frequency measures of inflation expectations. Out of sample forecasts confirm the findings.
    Keywords: inflation; expectations; sentiment; TIPS; surveys; forecasting; Michigan; SPF; Livingston; time-series; econometrics; inflation; predictive power; out-of-sample forecasts; high frequency; Rational Expectations Hypothesis; Efficient Markets Hypothesis; hypothesis testing; inflation forecasting
    JEL: C51 C52 C12 G00 E47 D84 E58 E30 C02 G14 C82 E31 E44 C32 C13 D03 C53 C20 C22 C42 D83 C81 G10 E37 C01
    Date: 2011–06–29
  26. By: Daniel Daianu
    Abstract: This paper focuses on roots of strain in the European Monetary Union (EMU). It argues that there is need for a thorough reform of the governance structure of the Union in conjunction with radical changes in the regulation and supervision of financial markets. Financial intermediation has gone astray in recent decades and entailed a big bubble in the industrialized world. Waves of financial deregulation have enhanced systemic risks, via speculative behavior and growing inter-connectedness. Moreover, the EMU was sub-optimal from its debut and competitiveness gaps did not diminish against the backdrop of its inadequate policy and institutional design. The euro zone crisis is not related to fiscal negligence only; over-borrowing by the private sector and poor lending by banks, as well as a one-sided monetary policy, also explain this debacle. The EMU needs to complement its common monetary policy with solid fiscal/budget underpinnings. Fiscal rules and sanctions are necessary, but not sufficient. A common treasury (a federal budget) is needed in order to help the EMU absorb shocks and forestall confidence crises. A joint system of regulation and supervision of financial markets should operate. Emergency measures have to be comprehensive and acknowledge the necessity of a lender of last resort; they have to combat vicious circles. Structural reforms and EMU level policies are needed to enhance competitiveness in various countries and foster convergence. The EU has to work closely with the US and other G20 members in order to achieve a less unstable global financial system.
    Keywords: Integration, Financial crisis, EMU, Sovereign debt, Governance reform
    JEL: F15 F36 F41 G21 H60
    Date: 2012

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