Wednesday, June 15, 2011

RM - Return to roots - Robert Mundell 1999 - The Euro and the Stability of the International Monetary System

The Euro and the Stability of the International Monetary System
Robert Mundell
Columbia University
January 1999

 "The introduction of the euro at the beginning of 1999 promises to mark a turning point in the international monetary system. It is often compared with the transformation of the international monetary system in the early 1970s from the system of fixed exchange rates endorsed at the Bretton Woods conference to the regime of managed flexible exchange rates. But in fact its significance is deeper. The collapse of the Bretton Woods arrangements did not alter the power configuration of the international system. Both before and after the breakdown, the dollar was the dominant currency. The introduction of the euro, on the other hand, will challenge the status of the dollar and alter the power configuration of the system. For this reason the introduction of the euro may be the most important development in the international monetary system since the dollar replaced the pound sterling as the dominant international currency soon after the outbreak of World War I.(1)

If it is true that the euro will challenge the dollar in the system, will the new international monetary system be more or less unstable? The answer to this question depends in part on the meaning attached to stability. The word as defined in the dictionary has at least three relevant meanings: (a) the state or quality of being stable, or fixed; (b) resistance to change, or permanence; or (c) the tendency of an equilibrium position to be restored after an initial displacement. All three of these meanings have relevance to the euro, as indicated by the following three questions:

(a) Will economic variables, say exchange rates, fluctuate more or less as a result of the introduction of the euro?

(b) Will the euro create a new configuration of currency areas that will last for, say, several decades in the 2000s?

(c) Will the euro alter the convergence conditions of exchange rate dynamics: will it turn a stable system into an unstable one or aggravate any instability of the existing system?

These issues will be addressed in this paper. First, however, we shall try to see what history and theory says about how well the euro will stack up against the dollar. We begin by discussing the characteristics of currencies that have in the past become successful "dominant" international currencies..."


"...The most urgent focus for management will be on the dollar-euro rate. As the world moves from monetary unilateralism to bilateralism, policy coordination will become more important. Under unilateralism, other countries were comparatively free to fix or change their currencies against the dollar, with a kind of benign neglect of exchange rate on the part of the United States. That will no longer be possible with the euro. If intervention is required it will have to be cooperative. In view of the long period of transition from a mainly dollar world to a world in which the dollar and euro vie on equal terms, it may be necessary to develop the infrastructure capable of dealing with the problem.

International management of the dollar-euro rate will not be easy. Suppose the dollar is depreciating against the euro and it is agreed that intervention is desirable. Where should the responsibility for intervention lie? Should the U.S. support the dollar by selling reserves, or should Europe support the dollar by buying reserves? Action by the U.S., taken alone, without sterilization, is deflationary for the world economy; action by Europe is inflationary. Obviously action by the US would be desirable if there were excess inflation in the world economy, whereas action by Europe would be desirable if there were excess deflation. The division of responsibility would have to be determined by an inflation index for the world economy. If gold were stable in terms of commodities the price of gold would itself serve as a satisfactory index..."

Source: The Euro and the Stability of the International Monetary System (does not open straight)

No comments:

Post a Comment