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Optimal Currency Areas: Why Does The Exchange Rate Regime Matter?

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Author Info
Buiter, Willem H

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Abstract

Microeconomic efficiency and market transparency argue in favour of UK membership in EMU and for Scotland's membership in the UK monetary union and also in EMU. UK seigniorage (government revenues from money issuance) would be boosted by EMU membership. Lender of last resort arrangements would not be substantially affected by UK membership in EMU. The UK is too small and too open to be an optimal currency area. The same point applies even more emphatically to Scotland. The 'one-size-fits-all' , 'asymmetric shocks' and 'cyclical divergence' objections to UK membership are based on the misapprehension that independent national monetary policy, and the associated nominal exchange rate flexibility, can be used effectively to offset or even neutralise asymmetric shocks. This 'fine tuning delusion' is compounded by a failure to understand that, under a high degree of international financial integration, market-determined exchange rates are primarily a source of shocks and instability. Instead, opponents of UK membership in EMU view exchange rate flexibility as an effective buffer for adjusting to asymmetric shocks originating elsewhere. I know of no evidence that supports such an optimistic reading of what exchange rate flexibility can deliver under conditions of very high international financial capital mobility. The economic arguments for immediate UK membership in EMU, at an appropriate entry rate, are overwhelming. Monetary union raises important constitutional and political issues. It involves a further surrender of national sovereignty to a supranational institution, the ECB/ESCB. It is essential that this transfer of national sovereignty be perceived as legitimate by those affected by it. In addition, the citizens of the UK have become accustomed to a high standard of openness and accountability of their central bank since it gained operational independence in 1997. The ECB/ESCB must be held to the same high standard, and, while there are grounds for optimism, there still is some way to go there.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2366.

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Date of creation: Jan 2000
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Handle: RePEc:cpr:ceprdp:2366

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Keywords: Asymmetric Shocks European Economic and Monetary Union National Sovereignty

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Find related papers by JEL classification:
F31 - International Economics - - International Finance - - - Foreign Exchange
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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  1. C Dougherty, 2000. "Numeracy, Literacy and Earnings: Evidence from the National Longitudinal Survey of Youth," CEP Discussion Papers 0478, Centre for Economic Performance, LSE. [Downloadable!]
  2. Salvador BARROS & Marius BRÜLHART & Robert J.R. ELLIOTT & Marianne SENSIER, 2001. "A Tale of Two Cycles: Co-Fluctuations Between UK Regions and the Euro Zone," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 01.10, Université de Lausanne, Faculté des HEC, DEEP. [Downloadable!]
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  3. H G Overman, 2000. "Neighbourhood Effects in Small Neighbourhoods," CEP Discussion Papers 0481, Centre for Economic Performance, LSE. [Downloadable!]
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  8. Stephen Nickell & Glenda Quintini, 2001. "Nominal Wage Rigidity and the Rate of Inflation," CEP Discussion Papers 0489, Centre for Economic Performance, LSE. [Downloadable!]
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  10. S Nickell & T Jones & G Quintini, 2000. "A Picture of Job Insecurity Facing British Men," CEP Discussion Papers 0479, Centre for Economic Performance, LSE. [Downloadable!]
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  13. Monika Blaszkiewicz-Schwartzman, 2007. "Explaining Exchange Rate Movements in New Member States of the European Union: Nominal and Real Convergence," Money Macro and Finance (MMF) Research Group Conference 2006 144, Money Macro and Finance Research Group. [Downloadable!]
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  16. G Duranton & V Monastiriotis, 2000. "Mind the Gaps: the Evolution of Regional Inequalities in the UK, 1982-1997," CEP Discussion Papers 0485, Centre for Economic Performance, LSE. [Downloadable!]
  17. Artis, Michael J, 2006. "What Do We Now Know About Currency Unions?," CEPR Discussion Papers 5677, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  18. Alexius, Annika & Post, Erik, 2005. "Exchange Rates and Asymmetric Shocks in Small Open Economies," Working Paper Series 2005:10, Uppsala University, Department of Economics. [Downloadable!]
  19. W. H. Buiter, 2000. "Monetary Misconceptions," CEP Discussion Papers 0469, Centre for Economic Performance, LSE. [Downloadable!]
  20. A. S. Litwin, 2000. "Trade Unions and Industrial Injury in Great Britain," CEP Discussion Papers 0468, Centre for Economic Performance, LSE. [Downloadable!]
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