Monetary Misconceptions

The paper identifies a number of misconceptions about the monetary policy process and the monetary transmission mechanism in the UK. Among the misconceptions about the process are the alleged lack of regional and sectoral representativeness of the Monetary Policy Committee and the view that operational central bank independence means that monetary and fiscal policy are not properly coordinated. Among the transmission mechanism misconceptions, the "New Paradigm" figures prominently. Among the New Paradigm changes in the British economy that have been given prominence are the following: increasing openness; lower global inflation; lower profit margins, reflecting stronger competitive pressures; buoyant stock markets; a lower natural rate of unemployment; and a higher trend rate of growth of productivity. I argue that the New Paradigm has been over-hyped and misunderstood as regards its implications for monetary policy. Other misconceptions include the 'death of inflation', the 'end of boom and bust', a couple of Neanderthal Keynesian fallacies and the monetary fine tuning fallacy.Monetary policy, inflation targeting, New Paradigm, stabilisation policy

Alice in Euroland

The paper contains a detailed critique of the common currency arrangements of the Economic and Monetary Union, embodied in the laws and emerging procedural arrangements that govern the actions of its key institutions: the European Central Bank and the European System of Central Banks. The main message here is 'Great idea, shame about the execution'. A number of improvements are then proposed. Some of these require amending the Treaty, including an end to the rule that each EMU member's national central bank has a seat on the Governing Council or the removal of the power of the Council of Ministers to give 'general orientations' for exchange rate policy. Others, notably in the areas of accountability, openness and transparency, could be implemented immediately, including publication of voting records, minutes and the inflation forecast. Improved arrangements are also advocated for the co-ordination of monetary and fiscal policy. And the article calls for a European Parliament that can both bark and bite.

Optimal Currency Areas: Why Does the Exchange Rate Regime Matter? (With an Application to UK Membership in EMU)

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.European Economic and Monetary Union, asymmetric shocks, national sovereignty

UDROP: A Small Contribution to the International Financial Architecture

The purpose of the UDROP proposal is to prevent debt rollover crises for foreign-currency-enominated debt instruments. For such liabilities, there is no international analogue to the domestic lender of last resort or to domestic deposit insurance. UDROP stands for Universal Debt Rollover Option with a Penalty. Our proposal is that all foreign currency liabilities should have a rollover option attached to them. The 'pure' version of the option would entitle the borrower to extend or roll over his performing debt at maturity for a specified period. The pricing of the option would be left to the contracting parties. A number of variants on the basic version are also considered. These make the individual borrower's ability to exercise his option contingent on the prior declaration of a state of 'disorderly markets', by the national central bank, the International Monetary Fund or an indicator of 'disorderly markets'. All versions of the scheme have the property that no commitment of public money is required, either by national governments or by international agencies such as the International Monetary Fund or the World Bank. The UDROP proposal is rule based and general: it is mandatory for all foreign-currency debt and automatic. That is, it is exercised at the discretion of the borrower. This stands in sharp contrast to the current practice of discretionary and politicised refinancing arrangements cobbled together in an ad-hoc manner on a case-by-case basis by the International Monetary Fund. UDROP is market-oriented: the terms and conditions on any foreign-currency loan and associated rollover option would be negotiated by the lenders and borrowers.

Budgetary Aspects of Stabilization and Strucutral Adjustment in India: The Painful Road to a Sustainable Fiscal-Financial-Monetary Plan

This study updates and extends to the period 88/89-92-93 our earlier analysis of the public finances of India. With the collapse of the communist regimes in the former Soviet Union and Eastern Europe, India found itself, by early 1991, in the unenviable position of having possibly the most over-regulated economic system in the world. In addition, there had been, during the eighties, a break with India's long tradition of fiscal prudence. Following the foreign exchange crisis of 1991, the government implemented a package of restrictive fiscal and monetary measures and a, by Indian standards, ambitious program of structural adjustment and reform of the Union budget, of regulation and licensing, of the domestic financial sector and of international trade and international financial relations. As regards the magnitude of the fiscal corrections that were undertaken, our conclusion is that it was insufficient. Continuations of past and present expenditure and revenue patterns would result in a steady increase in the public debt-GDP ratio and in the discounted value of the public debt. Inflationary financing of the "primary" gap is not a viable option. We calculate that a further permanent increase in the public surplus of about four and a half points of GDP is needed to achieve the modest objective of stabilizing the public debt-GDP ratio. On the reverse side, this necessary increase in the primary surplus is best achieved by expanding the direct and indirect tax bases and improving tax administration, collection and enforcement. On the expenditure side, reductions in the general government wage bill (by reductions in employment rather than by public sector wage cuts), in fertilizer subsidies, in some (but not all) food subsidies and in operating and capital subsidies to public sector enterprises are recommended. For efficiency reasons and to support the proposed expenditure cuts, overwhelming majority of the public sector enterprises should be cut off from the further government subsidies and be privatized or corporatized.

Aspects of Fiscal Performance in Some Transition Economies Under Fund-Supported Programs

This paper contains a selective review of some of the key fiscal issues faced by transition economies. The twelve countries that provide the empirical background for this study have all been under Fund programs for at least some of the time since they initiated their transitions from plan to market. The focus of the paper is on medium- and longer-term fiscal issues, such as government solvency and the evaluation of the sustainability of the government's fiscal-financial-monetary program. The purpose of the paper is to assist the design and implementation of the future Fund programs and to improve the quality of the debate about the design and conduct of fiscal policy in transition economic generally. The outline of the paper is as follows. Following the introduction, which contains a brief discussion of the roles of the Fund, Section 2 sets out a framework for evaluating the sustainability if the fiscal -financial-monetary program of the state. Section 3 contains some numerical material on public debt, deficits (including quasi-fiscal deficits) and monetary financing or seigniorage. Section 4 discusses eight specific budgetary issues I consider to be of special relevance to transition economics. Section 5 concludes by summarising the lessons from this study in a number of propositions.

Macroeconomic Policy During a Transition to Monetary Union

The main conclusions of the paper are the following: - In order to minimize switching costs, the name of the new EU currency should be the D-mark - Differential national requirements for seigniorage revenue provide a weak case for retaining national monetary independence. - From the point of view of adjustment to asymmetric shocks, nominal exchange rate flexibility is at best a limited blessing and at worst a limited curse. - Inter-state labour mobility in the USA does not compensate for the absence of state-level exchange rate flexibility. - The absence of significant inter-member fiscal redistribution mechanisms in the EU is not an obstacle to monetary union. - Convergence or divergence in real economic performance is irrelevant for monetary union. - A common currency is the logical implication of unrestricted international mobility of financial capital. - The Maastricht criteria are unlikely to hinder monetary union. - There are no convincing economic objections left to monetary union in the EU.

Interpreting the ERM Crisis: Country-Specific and Systemic Issues

Most interpretations of the Exchange Rate Mechanism crisis in 1992-93 ignore the key role played by structural policy spillovers among European countries, and overlook the effects of coordination (or lack thereof) of monetary and exchange rate policies among the countries making up the periphery of the system. This paper provides a simple analytical framework, able to encompass the recent literature on currency crises, while developing it by bringing out the decisive role of the strategic interactions among national policy makers in a multi-country monetary and exchange rate game. In contrast to an approach that focuses exclusively on country-specific issues, a systemic view is ultimately able to unravel more coherently, and more convincingly, the "puzzles" of the ERM crisis.

Promoting an Effective Market Economy in a Changing World

In this paper we examine the main challenges in promoting an effective market economy. While the paper ranges widely across the spectrum of economic institutions and policies, the central theme is the importance of macroeconomic stability for economic growth in the medium and long run. Macroeconomic stability may be seen as a public good. Its provision is among the essential responsibilities of the state both in modern market economies and in economies transforming themselves into modern market economies. Following this brief introduction, Section II considers four key aspects of the economic environment of the coming decade: increasing internationalisation; market-orientation; diminished government role; high real interest rates. Section III reviews the reasons why macroeconomic stability matters for economic performance and summarises the key empirical evidence supporting the existence of a causal link. Section IV deals with the design of domestic and international policies and institutions to promote macroeconomic stability and Section V asks how national governments and international institutions can take advantage of the current relatively stable global macroeconomic environment to improve medium-term growth. Section IV concludes. While our discussion will range broadly both theoretically and empirically, we shall emphasise lessons for , and experience from, countries attempting to create a market economy.

Enterprises in Transition: Macroeconomic Influences on Enterprise Decision-Making and Performance

This paper analyses the theoretical arguments and empirical evidence linking enterprise performance in transition economies to the macroeconomic environment. Macroeconomic instability is traced to the unsustainability of the fiscal-financial and monetary programmes of the state and to regulatory and other failures leading to problems with the solvency of financial institutions. The importance of macroeconomic stability for enterprise performance is documented with a simulation study and by reviewing relevant microeconomic and aggregate empirical evidence from across the world, as well as from the transition economies themselves. Conclusions are reached about the speed of transition, about the synergy between macroeconomic stabilisation and market development and about the creation of institutions for achieving and maintaining macroeconomic stability.