Foundations of European Central Bank Policy

251 Pages·1993·11.926 MB·English

by  Wolfgang Gebauer (auth.), Professor Dr. Wolfgang Gebauer (eds.)

Studies in Contemporary Economics
Editorial Board
D.Bos
B. Felderer
B. Gahlen
H. 1. Ramser
K. W. Rothschild
Wolfgang Gebauer (Ed.)
Foundations
of European Central Bank
Policy
With 36 Figures
Springer-Verlag Berlin Heidelberg GmbH
Professor Dr. Wolfgang Gebauer
Johann Wolfgang Goethe-Universitiit
Professur fUr Geld und Wiihrung
Zeppelinallee 29
D-6032S Frankfurt/Main, FRG
Die Deutsche Bibliothek -CIP-Einheitsaufnahme
Foundations of European central bank policy/
Wolfgang Gebauer (ed.). -Heidelberg: Physica-Verl., 1993
(Studies in contemporary economics)
ISRN 978-3-7908-0690-8 ISDN 978-3-642-50302-3 (eRook)
DOl 10.1007/978-3-642-50302-3
NE: Gebauer, WOlfgang [Hrsg.1
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Table of Contents
o
Introduction .................................................................................................... 1
1 Part I: Endogenous Money
1.1 The Money Supply Approach: Empirical Evidence for Germany
(M. Willms, Kiel)........................................................................................... 11
1.2 Endogenous Money and Interest Rates in Germany
(M. Miiller, Frankfurt).................................................................................. 35
1.3 The Endogeneity of Money: Concepts, Methods and Doctrinal
Influence of Monetary Theory
(A Beyer, Frankfurt) .................................................................................... 49
1.4 Currency Competition and Endogenous Money: Experiences from
the Suffolk System, 1819-1858
(S. Kalb, Firenze) .......................................................................................... 61
2 Part IT: Towards an Enropean Central Bank Policy Design
21 Economic Convergence and Monetary Union
(F. Papadia, C. Schioppa, Roma)............................................................... 79
22 Five Years to Prepare the Final Stage of EMU: A German View
(H.-J. Treutler, Frankfurt) ........................................................................... 103
23 Towards a Common Monetary Policy in the Transition: The Role
of Ecu and Required Reserves
(D. Gras, Bruxelles) ...................................................................................... 119
2.4 Fiscal Policy Implications of the European Union
(p. Della Posta, Firenze).............................................................................. 135
25 The (Term) Structure of Interest Rates as a Predictor of Real
Economic Growth: An Econometric Analysis for Germany
(K. Schmidt, Frankfurt)................................................................................ 165
26 The Evolution of Ecu Markets
(A Steinherr, Luxembourg) ........................................................................ 191
3 Part m: External Issues
3.1 Economic Transformation and the Integration of Central and
Eastern Europe in the European Community
(s. Collignon, Paris) ...............................................•....................................•. 209
3.2 Convertibility in Eastern Europe
(A Valentinyi, Budapest) ............................................................................ 225
3.3 Exchange Rate Pegging to the Ecu in Northern Europe: A Nordic
View
(S. Ranki, Helsinki) ....•.•....•••....•.......•.••...•.•....••.••.••..••..•.•••.......•.•.•...•......•.•.• 241
Introduction
European central bank policy is already taking place today in an informal way. It
comprises, in short, European exchange rate management and interest rate policy
decisions within and without the European Monetary System (EMS). A focal point
of such policy actions are the money market operating targets of European Central
Banks. Those central bank policies appear to be dominated, however, by the
Deutsche Bundesbank. This has caused recurring critical discussion of European
asymmetries and German leadership in monetary stabilization pOlicies, before and
after the EMS turbulences of September 1992. However, it should be pointed out
that German dominance has increasingly evolved in a cooperative way, ever since
the Committee of European Central Bank Governors began to meet regularly in
1964; the Basle-Nyborg accord of 1987 formed a further stage of cooperative efforts
within the EMS.
Presently, a small group of countries (including Benelux and Austria) generally
follows, after prior 'concertation', German monetary policy patterns. In this narrow
sense, there exists a European central bank policy within a "Deutsche-Mark-Zone".
In a broader sense, European central bank policy is shaped, after proper
consultation, by monetary cooperation between the larger EMS countries, but once
again dominantly influenced by Germany; recent problems of highjnterest rates in
France and elsewhere due to (relative) restrictive German monetary pOlicies are
striking examples.
German monetary dominance, in the narrow or broad sense, obviously creates, in
the long-run, an untenable situation in the eyes of European partner countries.
And this is precisely where the main argument for implementation of the
Maastricht treaty comes in: it provides a scheme for balanced cooperation between
European countries by explicitly sharing responsibilities and progressing towards
monetary and economic union. Indeed, it should be envisaged that the second stage
of this integration process will begin in January 1994, as originally planned. We
shall witness, in particular, a "mutation" of the old Basle Committee of European
Central Bank Governors into a European Monetary Institute (EMI), laying the
ground for a future European Central Bank System.
However, the analytical foundations of future European Central Bank policies
are seriously incomplete, to say the least. Most important, the main theoretical and
empirical foundations of monetary targeting have been progressively crumbling
away during the last decade. Given the international evidence of downgrading or de
facto abandoning of monetary targeting, traditional monetarist views ona _basic
central bank policy design are to be seriously questioned. In addition, the
implementation of future European central bank policies faces many unresolved
instrumental, operational and institutional issues. Finally, open analytical .. 1!I)9
~nceptual questions exist with countries outside the forthcoming EuropellIl
monetary union (EMU) - including those countries that are presently member of
the EMS but might not quaIiJY for EMU.
2 Wolfgang Gebauer
The present volume tries to tackle these issues in a selective way; there can be, of
course, no attempt to treat all - so far missing or controversial - foundations of
European central bank policy in a comprehensive way. In Part I, the basic,
century-old issue of the exogeneity of money is addressed. Thereafter, operational
and institutional problems of an optimal European policy design are dealt with,
including the Ecu. In a final third part, selected external issues are taken up.
Except for two contributed articles, all papers were presented, in a preliminary way,
at an international workshop on "Foundations of European Central Bank Policy",
held at the European University Institute (EUI) in Florence in June 1992. The
present volume summarizes in selected articles the topiCS that have been discussed.
The first part opens with an empirical study of Manfred Willms (University of Kiel)
in which the author claims the German money stock, narrowly defined as MI, to be
controllable by the Deutsche Bundesbank. But broadly defined monetary
aggregates, such as M3, are not dominantly influenced by monetary base control, as
variations in the relevant money multiplier are too large. Since these variations
consist of unpredictable changes in the coefficients of the multiplier coefficients,
they can in fact not sufficiently be anticipated. Willms concludes that the German
monetary base is endogenously determined by the multiplier in so far as the
Bundesbank uses M3 as monetary target variable.
The money-supply approach in general is critizised by Matthias Miiller
(University of Frankfurt/Main) who - pointing at the institutional factors of the
money creation process and the refinancing mechanism in Germany -stresses that
the Bundesbank has too often failed to hit its monetary targets in the past. He
considers the money stock being determined by real factors, i.e. fiscal policy or real
wages. For that reason Mllller supports a concept of "endogenous money" and
abandons the often used idea of an exogenous money supply. The seemingly high
success of the Bundesbank in keeping inflation rates low in a European
comparison is only due, in his view, to the high degree of credibility of the
Bundesbank which leads the markets to perform 'self-fulfilling expectations' on the
effectiveness of monetary policy instruments with respect to a pre-announced
anti-inflationary monetary policy.
The critique on the concept of exogenous money supply is strengthened by
Andn:as Beyer (University of Frankfurt/Main) who examines several concepts of
exogeneity and causality and finds that the result of empirical work on the
exogeneity of money is closely related with the used definition of exogeneity and
causality, respectively. After shOwing that the definition of causality by Granger and
the empirical work of Sims based on testing Granger-causality is insufficient with
respect to identification restrictions and the completeness of the model
("Lucas-critique"), Bayer introduces the three concepts of exogeneity established by
Engle/Hendry/Richard (weak, strong and super exogeneity). Super exogeneity in the
sense of Engle/Hendry/Richard includes the structural invariance of the model with
Introduction 3
respect to the parameters of interest and therefore takes account of the
Lucas-critique. Bayer concludes that super-exogeneity cannot be found for the
money stock. It follows that -in contrast to a monetarist point of view -the money
supply is potentially determined by the price level, and not vice versa.
From this point of view a monopoly on central bank money is not necessary for
the functioning of the monetary and financial system. Stefim KaIb (EUI, Florence)
analyzes the working of "currency competition" by looking closely on the historic
example of the 'Suffolk System" in New-England, 1824. He comes to the result
that such a liberal form of money-"supply" may on the one hand enhance welfare
by making the financial system more effective but on the other hand does not
necessarily imply danger for price stability. According to its endogenous character,
money can only be expanded by an enhanced money demand of the public which
itself does not bear inflationary pressure.
The second part begins with a paper by Francesco Papadia and Ciro Schioppa
(Banca d'Italia, Rome) analyzing the improvement in the process of economic
convergence to enter the final phase of the European Monetary Union. A
comparison between the progress still to be made by the member countries and the
development of the convergence criteria variables from 1979 to mid-l992, leads the
authors to the result that reaching the convergence criteria of the Maastricht treaty
until 1996 is still possible for all EC member states except Greece, if the positive
development of the respective variables can be assumed to continue in the future.
This optimistic view is not shared by Haus-Jilrgen Treutler (Hessische
Landeszentralbank, Frankfurt/Main) who misses necessary institutional patterns for
a successful stabilization policy and a sufficient social consensus on a strong
anti-inflationary monetary policy in some European member states. He claims a
considerable part of the success of some countries not to result from their own
stabilization policy but from pegging their currency to the D-Mark. Nevertheless,
the convergence criteria written down in the Maastricht treaty can be interpreted,
in his view, as a sign for the willingness to perform stabilization policies in all
relevant countries. However, the obvious impossibility of some member states to
fulfil the criteria may carry the danger that in the end the criteria will not be taken
too serious. Expecting this, Treutler fears that many countries might reduce their
efforts, thus endangering the whole project. In his view, it is necessary to gain
credibility for the unification process as a whole and for monetary policy in special.
To achieve the latter, monetary targeting should be continued, as it has performed,
according to Treutler, adequately in terms of anti-inflationary policy in the past.
The organization of monetary policy in the transition to EMU, i.e. in phase II of
the Delors report, is analyzed in a contributed paper by Daniel Gros (CEPS,
Bruxelles). In phase II the European Monetary Institute will begin to implement
European monetary policy actions, whereas the ultimate responsibility for monetary
policy remains in the hands of the national central banks and governments. The
4 Wolfgang Gebauer
question therefore is how to control overall European monetary expanSion, given a
continued high degree of autonomy for the national central banks. Gros argues
that control of the money stock cannot be technically executed via a clearing
system, because the EM! will not be able to rely on a stable demand for clearing
balances by commercial banks, since clearing will be mainly done at the national
level in national currencies, nor through control of the demand of the public for
currency in circulation, since the common Single currency will be introduced only in
the final stage of EMU. For that reason Gros proposes a uniform community-wide
reserve requirement system to put an upper limit on total monetary expansion
during the transition period. Nevertheless, because of its 'tax-on-deposits' character,
reserve requirements are not seen to be an ideal instrument of monetary policy in
general.
Pompeo Della Posta (EUI, Florence) examines the reasons in favour of
coordination, autonomy or discipline of fiscal policies in the European Union
against the background of the convergence criteria. Before analyzing strategic
games between a domestic treasury and different players (national central bank,
European central bank, foreign treasury, private sector) he first presents the main
arguments for the three fiscal policy regimes. Della Posta fears that countries that
are well within the limits imposed by the Maastricht treaty probably feel authorized
to run expansionary fiscal policies such that there might be a tendency in some
countries to exploit the "room of manoeuvre" left in the treaty.
The possibility of using the term structure of interest rates (yield curve) to
predict business cycles is discussed in a paper by Klaus Schmidt (University of
Frankfurt/Main). By using LSE-estimation techniques, he finds the spread (the
difference between a long-and a short-term interest rate, indicating the slope -not
the level -of the yield curve) to have predictive power for growth rates of German
real GNP up to 1.5 years into the future. According to his results, an inverse yield
curve (with higher short-term rates than long-term rates) indicates a forthcoming
decline in the growth rates of real GNP and vice versa. However, a satisfying
theoretical background for this empirical phenomenon is still missing. A close
relationship between the spread and several components of GNP (consumption,
investment in buildings and investment in equipment) can nevertheless be claimed.
The possibility remains to use the spread in order to forecast real GNP growth. If
the spread would reflect central bank policy in a consistent and symmetric way, the
term structure of interest rates could be seen as a serious candidate for an
indicator on a European level.
Alfred Steinherr (Em, Luxemburg) concentrates, in a contributed article, on the
role of the Ecu. The Ecu is described as a complicated weighted currency basket
based on the 12 community currencies, its weights being a function of current
exchange rates which thetnselves are a function of the particular international
interest rate differentials. Steinherr points out that the Ecu as a weighted basket
(resp. as a diversified portfolio) and the Ecu as a currency are two different
Introduction 5
sUbjects: there is no risk-free arbitrage forcing returns of both to equih"briate even
if transaction costs are considered. As a result, the Ecu can be regarded
.independent of the basket. Steinherr defines the ojJicia/ Ecu as being created by the
EMS treaty and used for certain official transactions and by the central banks. In
contrast, the private Ecu has developed in the markets as a financial innovation,
with the contracting parties denominating payment obligations in Ecu, thereby
accepting its official definition. The abstract Ecu is conceived by Steinherr as the
future single European currency that will be established according to the
Maastricht treaty, independent of the basket definition. The advantage of the
private Ecu prior to the establishment of EMU and one of the major reasons for
its success (besides the diversifaction argument) is seen against this 'abstract'
function -i.e. that Ecu will be the single European currency in stage TIL For this
reason, Steinherr anticipates that the private Ecu will perform a considerable
growth phase, prior to stage TIl of EMU, indicating that the public intends to
exploit the advantages of the forthcoming larger European financial markets.
The third part of the volume considers external issues and starts with a paper by
Stefim Collignon (AUME,Paris) analyzing the possibilities of integrating the
Central and Eastern European countries to EMU. To reduce inflation and to
render money scarce, i.e. to establish the main precondition to regain the store of
value function of money, several tasks of systemic transformation are identified:
privatization to clarify property rights and to enable economic decision making,
price liberalization to give companies the autonomy to manage resources and
production in accordance with money market signals, currency convertibility in
internal and external markets to make integration into world markets feasible,
stabilization of public finance to reduce budget deficits and to build up an efficient
tax system, and appropriate income and exchange rate policies. According to
Collignon, the Ee should furnish external support to reach these aims by accepting
Association Agreements in the short-run and by installing an Ecu-Zone consisting
of an Ecu-Zone Surveillance Board, a Reserve Pool & Stabilization Fund and an
Exchange Rate Mechanism in the long-run. Such arrangements might provide
greater confidence in the economic development of the Eastern and Central
European countries, thus encouraging potential investors.
Atos Valentinyi (Institute for Economic and Market Research, Budapest) uses
the example of Hungary to describe the problems of Eastern European countries in
achieving currency converu"bility on the way to a market oriented economy. After
analyzing several different definitions for currency convertl"bility, the conditions for
its introduction are examined. Valentinyi finds that the benefits and costs of
currency convertl"bility depend crucially on the manner of its introduction: a fast
h"beralization probably leads early to the benefits of currency convertibility -
sharper competition in the domestic market, rapid development of the new price
system expressing relative scarcities, better adjustment capability of the economy,
6 Wolfgang Gebauer
increase in investment propensity of non-residents - but might enhance the danger
of higher inflation; a slow liberalization may avoid this danger but instead lead to a
severe recession. After introduction of currency convertibility, its sustainability
must be confirmed. To achieve this aim, Valentinyi points out several central
factors, such as the tax system, the budget deficit, the institutional aspects of the
monetary system and the exchange rate regime that have to be taken into account.
Being aware of this broad field of problems and the lack of information about the
reactions of the economic agents during the transition period, Valentinyi concludes
that hberalization and introduction of currency convertibility should be carried out
carefully and stepwise, as the existing policy instruments cannot cope with possibly
upcoming shocks.
Not only the Central and Eastern European countries, but also the Nordic
countries try to establish tighter relations to the European Community. One of the
obvious signs of this development has been the exchange rate pegging of the
currencies of Norway, Sweden and Finland to the Ecu. This pegging is analyzed by
Sinimaaria Ranki (Swedish School of Economics and Business Administration,
Helsinki) from the Nordic point of view. She stresses that the composition of the
Ecu basket does not correspond to the composition of the foreign trade relations
between the Nordic countries and the EC member countries. If the pegging will be
sustained, an adaptation of the foreign trade relations to the structure of the Ecu
can be expected which will intensify the relations of the EC to the Nordic countries
towards a full membership. Therefore, the Ecu-pegging is justified more in political
than in economic terms; a strategy of adapting the foreign trade structure might
lead to a recession due to a fall in foreign demand which can already be observed
in Finland, as the empirical part of Ranki's paper shows. She concludes that it was
only a short-term gain in credibility being bought by Ecu-pegging. The positive
short-run effect was turned around by strong economic imbalances, leading to
devaluation. It follows that a pOlitically optimal but economically suboptimal
exchange rate commitment should be sufficiently credible to signal strong
anti-inflationary stabilization policies.
In retrospect, the workshop proved to be a unique and truly international event -
conceived at Frankfurt University, conducted at the premises of the European
University Institute in Florence, and. attended by scholars from ten countries. The
selected contributions assembled in this volume reflect such wide-ranging
participation. Indeed, it was precisely international scientific cooperation which
made the event a successful one. Recent, most deplorable developments as regards
"foreigners" in Germany are forcing me to state such a truism explicitly.
Finally, it should be emphasized that the workshop could not have taken place
without many helping hands. Most importantly, I would like to express my
gratitude and esteem to Secretary General Dr. Buzzonetti of the European
University Institute in Florence for his generous and decisive backing of the