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1999 | Book

European Monetary Union

Theory, Evidence, and Policy

Author: Prof. Dr. Michael Carlberg

Publisher: Physica-Verlag HD

Book Series : Contributions to Economics

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About this book

This book explores the new macroeconomics of the European Monetary Union. It carefully discusses the effects of shocks and policy measures on em­ ployment, prices, and the current account. Take for instance a shock or a policy measure in a specific union country. Then what will be the results in the specific country, in the other union countries, and in the rest of the world? The targets of economic policy are full employment and price stability in each of the union of economic policy are monetary policy by the Euro­ countries. The instruments pean Central Bank and fiscal policies by national governments. What is the appropriate policy mix? A salient feature of this book is the numerical estimation of shock and policy multipliers. Money wages are fixed, flexible or downward rigid. The monetary union can be small or large. I had many helpful talks with Gerd Focke, Daphni-Marina Papadopoulou, Franco Reither, Wolf Schafer, Christine Schafer-Lochte, and Michael Schmid. In addition, Michael Brauninger and Michael Cyrus carefully discussed with me all parts of the manuscript. Last but not least, Doris Ehrich did the secretarial work as excellently as ever. I wish to thank all of them. Executive Summary 1) Small monetary union of two identical countries, say Gennany and France. The monetary union is a small open economy with perfect capital mobili­ ty. Let us begin with fiscal policy.

Table of Contents

Frontmatter

Introduction

Introduction
Abstract
This book explores the new macroeconomics of the European Monetary Union. It carefully discusses the effects of shocks and policy measures on employment, prices, and the current account. What are the prospects and challenges that lie ahead?
Michael Carlberg

Brief Survey of the Literature

Brief Survey of the Literature
Abstract
As a starting point take the classic papers by Fleming (1962) and Mundell (1963, 1964, 1968). They discuss monetary and fiscal policy in an open economy characterized by perfect capital mobility. The exchange rate can either be flexible or fixed. They consider both the small open economy and the world economy made up of two large countries.
Michael Carlberg

Simple Models

Frontmatter
1. Small Country in Large Union
Abstract
The basic idea of this section is as follows. Consider for instance an increase in Belgian government purchases. The primary effect is that Belgian income goes up. The secondary effect is that the euro appreciates and the world interest rate rises. The appreciation of the euro, however, falls mainly on the other countries of the union. And the rise in the world interest rate falls mainly on the rest of the world. So there is clearly a spillover to the other countries. The repercussion to Belgium, on the other hand, is very small, compared to the size of the fiscal impulse. For a more profound analysis see the small union of two countries in part two and the large union in part four.
Michael Carlberg
2. Small Union as a Whole
Abstract
A monetary expansion by the European Central Bank gives rise to a depreciation of the euro. What will be the effect upon union income? On the other hand, a fiscal expansion by union governments gives rise to an appreciation of the euro. How will union income respond to this? And, third, what will be the implications of a wage shock to the union?
Michael Carlberg

Small Union

Frontmatter
Chapter 1. Small Union of Two Countries
Abstract
In this section we make the following assumptions. The monetary union is a small open economy with perfect capital mobility. For the small union, the world interest rate is given exogenously r* = const. Under perfect capital mobility, the union interest rate corresponds to the world interest rate r = r*. Thus the union interest rate is constant, too. The exchange rate between the union and the rest of the world is flexible.
Michael Carlberg
Chapter 2. Small Union of Three Countries
Abstract
The model can be captured by a system of four equations:
$$ {{\text{Y}}_{{\text{1}}}} = {\text{ c}}{{\text{Y}}_{{\text{1}}}} + {\text{ }}{{\text{I}}_{{\text{1}}}} + {\text{ }}{{\text{G}}_{{\text{1}}}} + {\text{ he }} - {\text{ q}}{{\text{Y}}_{{\text{1}}}} + {\text{ m}}{{\text{Y}}_{{\text{2}}}} + {\text{ m}}{{\text{Y}}_{{\text{3}}}} $$
(1)
$$ {{\text{Y}}_{{\text{2}}}} = {\text{ c}}{{\text{Y}}_{{\text{2}}}} + {\text{ }}{{\text{I}}_{{\text{2}}}} + {\text{ }}{{\text{G}}_{{\text{2}}}} + {\text{ he }} + {\text{ m}}{{\text{Y}}_{{\text{1}}}} - {\text{ q}}{{\text{Y}}_{{\text{2}}}} + {\text{ m}}{{\text{Y}}_{{\text{3}}}} $$
(2)
$$ {{\text{Y}}_{{\text{3}}}} = {\text{ c}}{{\text{Y}}_{{\text{3}}}} + {{\text{I}}_{{\text{3}}}} + {\text{ }}{{\text{G}}_{{\text{3}}}} + {\text{ he }} + {\text{ m}}{{\text{Y}}_{{\text{1}}}} + {\text{ m}}{{\text{Y}}_{{\text{2}}}} - {\text{ q}}{{\text{Y}}_{{\text{3}}}} $$
(3)
$$ {\text{M }} = {\text{ k}}{{\text{Y}}_{{\text{1}}}} + {\text{k}}{{\text{Y}}_{{\text{2}}}} + {\text{k}}{{\text{Y}}_{{\text{3}}}} $$
(4)
1 stands for union country 1, 2 for union country 2, and 3 for union country 3. Equations (1), (2) and (3) are the goods market equations. Equation (4) is the money market equation. The union countries are the same size and have the same behavioural functions. The parameters of the model are the marginal consumption rate c, the exchange rate sensitivity of exports h, the income sensitivity of money demand k, the marginal import rate relative to another union country m, and the overall marginal import rate q. The exogenous variables are national government purchases Gi? national investment Ii? and union money supply M. The endogenous variables are the union exchange rate e and national income Yi.
Michael Carlberg
Chapter 3. Small Union of Ten Countries
Abstract
Imagine an increase in Belgian government purchases. How does this impinge on Belgian income? And what about income in the other union countries? We start again from the premise that the union countries are the same size and have the same behavioural functions. The fiscal policy multipliers can be obtained in full analogy to chapters 1 and 2:
$$ \frac{{d{Y_{1}}}}{{d{G_{1}}}} = \frac{9}{{10(1 - c + q + m)}} $$
(1)
$$ \frac{{d{Y_{2}}}}{{d{G_{1}}}} = \frac{{d{Y_{3}}}}{{d{G_{1}}}} = \ldots = \frac{{d{Y_{{10}}}}}{{d{G_{1}}}} = - \frac{1}{{10(1 - c + q + m)}} $$
(2)
Michael Carlberg
Chapter 4. No Capital Mobility between Union and Rest of the World
Abstract
As a rule, in this book, we assume perfect capital mobility between the union and the rest of the world. As an exception, in this chapter, we assume no capital mobility between the union and the rest of the world. The regime of capital immobility will occur if foreign debt of the union exceeds a critical level. Alternatively, this regime will occur if capital controls are introduced to ward off speculative attacks. The investigation will be conducted within the following setting. The monetary union is a small open economy. Given that there is no capital mobility, there will be no link between the union interest rate r and the foreign interest rates. The exchange rate between the union and the rest of the world is flexible. For that reason, the current account of the union is always balanced.
Michael Carlberg

Small Union and Associated Countries

Frontmatter
1. Small Union as a Whole
Abstract
In this part, the associated countries are introduced into the model. Strictly speaking, we consider a regional economy that is made up of two subregions, the monetary union and the group of associated countries. The exchange rate between the union and the associated countries is fixed. The exchange rate between the union and the rest of the world is flexible. The same holds for the exchange rate between the associated countries and the rest of the world. Index 1 denotes the monetary union, 2 is the group of associated countries, and 3 is the rest of the world. Figure 1 visualizes the basic idea.
Michael Carlberg
2. Small Union of Two Countries
Abstract
Consider a regional economy that is made up of two subregions, the monetary union and the group of associated countries. The monetary union on its part is composed of two countries. Index 1 stands for union country 1, 2 for union country 2, 3 for the group of associated countries, and 4 for the rest of the world. The exchange rate between the union and the associated countries is fixed. The exchange rate between the union and the rest of the world is flexible. And the same applies to the exchange rate between the associated countries and the rest of the world. Figure 1 visualizes the approach.
Michael Carlberg
3. Summary
Abstract
In this part, the associated countries are introduced into model. In doing the analysis we proceed in two steps. To begin with, we inquire into the small union as a whole. After that, we probe into the small union of two countries.
Michael Carlberg

Large Union

Frontmatter
Chapter 1. Large Union and Rest of the World
Abstract
So far we considered a small monetary union. Now, instead, we shall consider a large monetary union. Properly speaking, the world economy consists of two regions, the monetary union and the rest of the world. We assume perfect capital mobility between the union and the rest of the world. Therefore the union interest rate agrees with the interest rate in the rest of the world r1 = r2. It is worth emphasizing that here the world interest rate r becomes endogenous. The exchange rate between the union and the rest of the world is floating. The union produces good 1, while the rest of the world produces good 2. P1 denotes the price of good 1, and P2 is the price of good 2. Without loss of generality, we postulate P1 = P2 = 1. e is the exchange rate of the union (e.g. the price of the dollar in terms of the euro). The initial value is set at e = 1.
Michael Carlberg
Chapter 2. Small Country in Large Union
Abstract
Fiscal policy in the small country. Take for instance an increase in Dutch government purchases. Then what will be the impact on Dutch income, on income in the other union countries, and on income in the rest of the world? To illuminate this, regard a numerical example. The parameter values of the large union (and, for that matter, of the rest of the world) are c = 0.72, k = 0.25, and b = j, cf. chapter 1 in part four. The parameter values of the small country are c = 0.72 and q = 0.24, cf. section 1 in part one. Now consider an increase in Dutch government purchases of 100. According to section 1 from part one, this causes an increase in Dutch income of 192. According to chapter 1 from part four, the policy action causes an increase in union income of 94, an increase in rest-of-the-world income of equally 94, and an increase in world income of 189. As a result, the policy action causes a decline in rest-of-the-union income of 98.
Michael Carlberg
Chapter 3. Large Union of Two Countries
Abstract
The world economy consists of two regions, the monetary union and the rest of the world. The monetary union, in turn, consists of two countries. We assume that the monetary union and the rest of the world are the same size and have the same behavioural functions. Moreover, we assume that the two union countries are the same size and have the same behavioural functions. Subscript 1 denotes union country 1, 2 is union country 2, and 3 is the rest of the world. Figure 1 visualizes the approach taken here.
Michael Carlberg
Chapter 4. No Capital Mobility between Union and Rest of the World
Abstract
As a rule, in this book, we assume that there is perfect capital mobility between the union and the rest of the world. As an exception, in this chapter, we assume that there is no capital mobility between the union and the rest of the world. The case of capital immobility can occur for two reasons. First, if foreign debt of the union exceeds a critical level. And second, if capital controls are introduced to prevent speculative attacks.
Michael Carlberg

Large Union and Associated Countries

Frontmatter
1. Large Union as a Whole
Abstract
The world economy consists of two regions:
  • the monetary union and the group of associated countries
  • the rest of the world
The exchange rate between the union and the associated countries is pegged. The exchange rate between the union and the rest of the world is floating. And the same applies to the exchange rate between the associated countries and the rest of the world. The two regions are the same size and have the same behavioural functions. Likewise, the monetary union and the group of associated countries are the same size and have the same behavioural functions. Index 1 denotes the union, 2 is the group of associated countries, and 3 is the rest of the world. Figure 1 visualizes the approach taken here.
Michael Carlberg
2. Large Union of Two Countries
Abstract
The world economy consists of two regions:
  • the monetary union and the group of associated countries
  • the rest of the world.
The monetary union, in turn, consists of two countries, say Germany and France. Apart from this we shall take the same approach as before. Consider for instance a domestic credit expansion by the European Central Bank. Then what will be the impact on Germany, France, the associated countries, and the rest of the world? In answering this question we assume that the union countries are the same size and have the same behavioural functions. Figure 1 portrays the basic idea. There is perfect capital mobility across regions, subregions, and countries.
Michael Carlberg
3. Summary
Abstract
In this part, the associated countries are introduced into the model. in doing this, we process in two steps. At first we discuss the large union as a whole. Then, later on, we study the large union of two identical countries.
Michael Carlberg

Synopsis

Synopsis
Abstract
A fiscal expansion in a specific union country raises the income of this country. However, it lowers the income of the other union countries. The effect on the aggregate of union income depends on the size of the union. In the small union, total income does not respond. In the large union, total income goes up. In any case, the income of the rest of the world goes up. And the same applies to world income. Tables 55 and 56 give an overview.
Michael Carlberg

Conclusion

Conclusion
Abstract
Let us begin with a small country in a large monetary union, say Belgium (section 1). The country in question is a small open economy with perfect capital mobility. For the small country, the foreign interest rate is given exogenously. Under perfect capital mobility, the domestic interest rate agrees with the foreign interest rate. As a consequence, the domestic interest rate is constant, too. Domestic output is determined by the demand for domestic goods. There is a single money market for the union as a whole. There is no separate money market for the small country.
Michael Carlberg
Backmatter
Metadata
Title
European Monetary Union
Author
Prof. Dr. Michael Carlberg
Copyright Year
1999
Publisher
Physica-Verlag HD
Electronic ISBN
978-3-642-86652-4
Print ISBN
978-3-7908-1191-9
DOI
https://doi.org/10.1007/978-3-642-86652-4