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External Effects of Currency Unions

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  • Thomas Plümper
  • Vera E. Troeger
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    Abstract

    Argument: The paper argues that the introduction of the Euro has considerably reduced de facto monetary policy autonomy in non-ECU members. We start from a simple Mundellian model, in which currency unions raise economic efficiency but reduce monetary policy autonomy. Our main argument holds that governments in countries that did not join the currency union lose monetary policy autonomy if the establishment of a currency union increases the size of the key currency area. The increase in the size of the key currency area has two external effects on countries remaining outside the currency union: Firstly, it renders stable exchange-rates to the currency union slightly more important, because the value of goods imported from countries within the currency union increases and because the countries inside the union have more synchronized business cycles. Secondly and more importantly, we claim that any given change in the real interest-rate differential leads to an exchange-rate effect, which is larger the smaller the domestic currency area is relative to the key currency area. Consequently, governments in non-member countries have to pay a higher price if they seek to stimulate the domestic economy. Hypotheses: a) Exchange-rate effects on changes in the real interest rate differential are larger, if currency areas are less equal in size. b) Outsider countries more closely follow the interest-rate policy of the currency union than they had previously followed the monetary policy of the anchor currency. Empirics: We employ a panel-GARCH model to estimate the impact of changes in the key currency real interest rate on the real interest rate of other countries. Specifically, we analyze the influence of Germany’s and the Eurozone’s monetary policy on the monetary policy of Great Britain, Denmark, Norway, Sweden, and Switzerland. Results: Our results support the assumptions underlying our model as well as our main argument. De facto monetary autonomy of countries remaining outside a currency union declines with the establishment of the union. ZUSAMMENFASSUNG - (Externe Auswirkungen von Währungsunionen) Der Artikel argumentiert, dass die Einführung des Euro die faktische geldpolitische Autonomie auch in Staaten reduziert hat, die der Europäischen Währungsunion nicht beigetreten sind. Das Argument basiert auf einem einfachen Mudellianischen Modell, in dem Währungsunionen die wirtschaftliche Effizienz steigern aber zugleich die geldpolitische Autonomie reduzieren. Wir zeigen über das Standardmodell hinaus, dass Länder, die der Währungsunion nicht beitreten, geldpolitische Autonomie einbüßen, wenn sich durch die Währungsunion die Größe des Leitwährungsraumes erhöht. Diese Vergrößerung des Leitwährungsraumes hat zwei Auswirkungen auf Länder außerhalb der Union: Erstens steigt die Bedeutung stabiler Wechselkurse leicht an, weil der Wert importierter Güter aus dem Währungsgebiet zunimmt und weil die Länder der Union stärker synchronisierte Konjunkturzyklen aufweisen als vor der Gründung der Währungsunion. Zweitens steigt durch die Vergrößerung der Leitwährung aber der Einfluss von Veränderungen der Zinsdifferenz auf die Wechselkurse zwischen Währungen außerhalb der Währungsunion und der Unionswährung an. Folglich müssen Länder eine stärkere Abwertung ihrer Währung hinnehmen, wenn sie die Zinsen senken, um die Konjunktur anzukurbeln. Wir testen dieses Argument anhand der zwei Kernhypothesen: a) Wechselkurse reagieren umso stärker auf Veränderungen der Zinsdifferenz, je größer der Leitwährungsraum ist. b) Länder außerhalb der Währungsunion folgen der Geldpolitik der Union stärker, als sie der Geldpolitik der Leitwährung vor Gründung der Union folgten. Wir greifen auf Panel-GARCH Modelle zurück, um den Einfluss der Geldpolitik der EZB relativ zum Einfluss der Bundesbank auf die Geldpolitik in Großbritannien, der Schweiz, Norwegen, Dänemark und Schweden zu testen. Die empirische Analyse bestätigt die aus dem formalen Modell abgeleiteten Hypothesen. Die faktische geldpolitische Autonomie der Länder außerhalb der Währungsunion sinkt mit deren Etablierung.

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    Bibliographic Info

    Paper provided by Wissenschaftszentrum Berlin (WZB), Research Unit: Competition and Innovation (CIG) in its series CIG Working Papers with number SP II 2004-06.

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    Length: 35 pages
    Date of creation: Apr 2004
    Date of revision:
    Handle: RePEc:wzb:wzebiv:spii2004-06

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    Keywords: Interest Rates; Monetary Policy Autonomy; Currency Unions; Bundesbank; European Central Bank;

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    References

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    1. Roberto Chang & Andres Velasco, 1998. "Financial Fragility and the Exchange Rate Regime," NBER Working Papers 6469, National Bureau of Economic Research, Inc.
    2. Bennett T. McCallum, 1999. "Theoretical Issues Pertaining to Monetary Unions," NBER Working Papers 7393, National Bureau of Economic Research, Inc.
    3. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June.
    4. Alberto Alesina & Robert J. Barro, 2002. "Currency Unions," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 409-436, May.
    5. Frankel, Jeffrey A & Rose, Andrew K, 1998. "The Endogeneity of the Optimum Currency Area Criteria," Economic Journal, Royal Economic Society, vol. 108(449), pages 1009-25, July.
    6. Jay C. Shambaugh, 2004. "The Effect of Fixed Exchange Rates on Monetary Policy," The Quarterly Journal of Economics, MIT Press, vol. 119(1), pages 300-351, February.
    7. Phillips, P.C.B., 1986. "Understanding spurious regressions in econometrics," Journal of Econometrics, Elsevier, vol. 33(3), pages 311-340, December.
    8. Rose, Andrew, 1999. "One Money, One Market: Estimating the Effect of Common Currencies on Trade," Seminar Papers 678, Stockholm University, Institute for International Economic Studies.
    9. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
    10. Bayoumi, Tamim & Eichengreen, Barry, 1996. "Operationalizing the Theory of Optimum Currency Areas," CEPR Discussion Papers 1484, C.E.P.R. Discussion Papers.
    11. Tamim Bayoumi and Barry Eichengreen., 1996. "Ever Closer to Heaven? An Optimum-Currency-Area Index for European Countries," Center for International and Development Economics Research (CIDER) Working Papers C96-078, University of California at Berkeley.
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