When to Give Up Monetary Policy?
I am going to leave my ardent watching of the recent flurry about the dollar for a while and indulge myself in a theoretical moment here at Alpha.Soures. The topic is monetary policy and more specifically when to give it up in terms of joining a monetary union, submitting to dollarization or setting up a currency board this last option admittedly being somewhat different. This question, primarliy posed from the perspective of small economies, is taken up by John Williamson in a recent (November 2006) policy brief for Peterson Institute for International Economics entitled Choosing Monetary Arrangements for the 21st century: Problems of a Small Economy. The paper's outline is the following ...
This policy brief first outlines the advantages of what I will term the “traditional” arrangement of one country, one money, managed by one central bank. I do not intend to challenge the view that this arrangement is relatively recent—it emerged in the 19th century and became dominant only after colonialism essentially disappeared in the second half of the 20th century—and was never universal (Helleiner 2003, Cohen 2004). The brief then notes that large parts of the world today are not organized in this traditional way and describes present arrangements. The heart of the policy brief follows in the next three sections: The first of these analyzes the advantages and disadvantages of sharing monetary sovereignty; the second offers a similar consideration of abandoning monetary sovereignty; and the third suggests what those considerations imply about the options facing Uganda. A short concluding section summarizes the argument.
The basic way to view the question of whether to share monetary sovereignty is to ask whether the political symbol of a common money, lower transactions costs (and therefore perhaps increased trade), and maybe better management of a common money outweigh the increased cost of having to adjust without the freedom to vary the exchange rate. A decision
to adopt another country’s currency demands a similar cost-benefit approach: a weighing of reduced transactions costs and increased trade and a higher probability of good monetary management against increased adjustment cost, lost seigniorage, and the political and diplomatic costs. The relevant considerations are laid out in table 1.
The brief's focus is a lot on Africa in terms of case studies which by the way is both interesting and educative reading. However, this is primarily making me think about the new countries in EU or more specifically the Eastern European and Baltic countries. Whether these countries will adopt the Euro at some point is as much about whether they are actually allowed that it is about whether they want to. So far, only Slovenia has been bid welcome and Lithuania was refused on the brink back in June. In general, EU's reluctance to let Eastern European countries join the Euro has been creating some political squabbles ...
(From Bloomberg 10.10.06 - linked above)
The EU's ``no'' to Lithuania marks the first time the EU has turned down a euro aspirant, setting the tone for larger countries such as Hungary and Poland that are struggling to pass the economic tests to switch to the euro in coming years
'Six eastern countries -- Poland, the Czech Republic, Latvia, Estonia, Lithuania and Slovakia -- protested today that a rigorous reading of the inflation rules will keep them out of the euro and delay the economic unification of Europe.'
More recently, The Economist also had a nice piece on the Eastern European countries' Euro prospects; the lesson seems to be that small economies (e.g. the Baltic countries) would do well to join the Euro whereas bigger countries such as for example Poland and Hungary would be better suited to stay out?
The case for small economies joining the euro is overwhelming, But for the (relatively) bigger ex-communist countries it is more complex. National currencies bring flexibility, but also vulnerability. Westerners are beginning to feel uncertain too. The euro zone may already have too many misfits (Italy, for example, or Greece). Even if prickly Poland and sleazy Hungary could eventually massage their statistics to meet the criteria, would bringing them into the inner sanctum really be advisable?
This is indeed difficult to generalize on and clearly the Eurozone in general should not pull in countries too easily in my opinion. There are enough to deal with in terms of structural imbalances as it is. Clearly then, we need to look at this at a case by case basis but in the end we also need to ask the fundamental question of whether the end goal is that the Eurozone becomes an EU-25 institusion so to speak?