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Inflationary Pressure and Labor
Conflict


Inflation in the 1960s jeopardized the corporatist
wage structure of the postwar period



In the late 1960s work stoppages began to occur
where workers demanded higher wages

Factors Leading to Friction in the
Labor Market

1)

Decline of agricultural workers to less than 15% of
employment continent
-
wide


Elastic supplies of labor in underemployed agricultural
workers no longer exists

2)

Unemployment as a whole declined leaving the threat
of unemployment as a restraint on wage demands as no
longer a viable option

3)
Wage and price inflation did not subside even when
unemployment rose, which indicated there were other
factors at work


Young no longer remembered what it was like to be
unemployed


People were no longer willing to sacrifice themselves for
postwar reconstruction and preferred immediate
gratification instead

Factors Leading to Friction in the
Labor Market (cont.)

4)

The Soviet threat was seen as less immediate,
removing one immediate incentive for labor and
capital to pull together

5)

Another important event in this time period was
the weakening and final breakdown of the Bretton
Woods system in the 1970s


Exchange rates were fixed and then inflation became
temporary, with its breakdown, this was no longer the
case


Unions started to fear inflation and wanted wage
increases

Friction in the Labor Market
(cont.)


Wages started to grow but production slowed



Profits began to fall right before the 1973
-
1974 oil
price shock



Governments tried to contain inflation with
controls (such as a statutory freeze on wages and
prices)


These tactics were not very successful

Contradictions of Corporatism

1973 OPEC Oil Crisis and the Rise
of Oil Prices

Contradictions of Corporatism


Countries began to promise workers more benefits in
exchange for wage restraint


But, financing these benefits was very expensive


Where the institutions of corporatism were most
advanced, their reinforcement limited the rise in labor
costs and the rate of unemployment


After the wage explosion of 1974
-
75, wage increase
slowed


Inflation wasgetting worse and making things difficult
to handle


Keynesian demand stimulus was used to keep
unemployment levels down


However, the golden years of Europe were over

Contradictions of Corporatism
(cont.)


Recession came about


The 2
nd

OPEC oil
-
price shock at the end of the 1970s
made things even worse


Unions no longer wanted to practice wage
constraint


Public employment (and hiring) had gone up for
the last recession and was no longer a viable option
to use


Social corporatism began to crumble and by the
mid
-
eighties it was in retreat

Retreat Into Regional Integration


European governments tried to create economic
stability with the process of European integration


UK, Ireland, and Denmark joined the EEC


A new system needed to be put in place to replace the
now defunct
Bretton

Woods system


European countries did not want uncontrolled
exchange rates


Europe's response was “The Snake”
-

December 1971


Participating countries held their exchange rates within
narrow margins and established financing facilities to
extend credits to one another


However, they still lacked a convergence in their monetary and
fiscal policies

Retreat Into Regional Integration
(cont.)


Countries with inflationary policies were driven
from the Snake


The UK was the first to withdraw in June 1972


Denmark withdrew one week later but returned in
October


Italy withdrew in 1973


France was forced to float in January 1974


Sweden withdrew in 1977


Norway withdrew in 1978

The Snake

Retreat Into Regional Integration
(cont.)


France and Germany wanted political and monetary
integration for exchange rate and inflation stability


A new system came about in 1979


European Monetary
System


A better version of the Snake


Participants had to hold their currencies within 2.25%
to fluctuation bands, but countries were allowed to
revalue and devalue


8 out of the 9 EC members joined the EMS at the
beginning (except UK)


No one was forced to withdraw in the 1980s although there
were realignments


Yet the poor coordination of macroeconomic policies
strained the EMS

Rising Unemployment and the
Integrationist Approach


The 1980s were a decade of dissapointment for
growth and productivity for Europe



Unemployment was still high



Causes of the problem


1)
Inadequately flexible wages

2)
Overly rigid work rules

3)
Excessive labor costs

Rising Unemployment and the
Integrationist Approach (cont.)


Another solution was looked at in integration


deeper
integration adding free movement of capital and labor
to the existing customs union


The aim was to be like the US so European producers could
exploit economies of scale and compete internationally


This came with the Single European Act (SEA) in 1986


signatories agreed on the creation of a single market free of
internal barriers to trade


The Maastrict Treaty (early 1990s) was the next step


There was a commitment to move to a monetary union (a single
monetary policy, a European Central Bank and a single currency)

Rising Unemployment and the
Integrationist Approach (cont.)


Removing capital controls was important for monetary
integration


The elimination of controls made the EMS more fragile
because countries were now faced with destabilizing
capital flows


If investors thought a country was going to realign its
exchange rate, there was a massive outflow of funds


There were no more realignments


Fixed Exchange Rates, International Capital Mobility
and Monetary Independence are mutually incompatible


Europe had to choose between fixed exchange rates and
independent monetary policies


Common currency was the best option

Rising Unemployment and the
Integrationist Approach (cont.)


For countries other than Germany which had to
follow the Bundesbank's policies, now they could
have more say in their monetary destinies



They had no representatives on the Bundesbank but
would have representatives on the ECB



An alternative to this was to face FX
-
volatility

Rising Unemployment and the
Integrationist Approach (cont.)


Guided by the Delors Report, a three
-
step transition
of the Maastricht Treaty to a monetary union:

1)
Stage I (1990
-
93)
: countries bring their national
economic policies more closely in line, remove
remaining capital controls and butress the
independence of their central banks

2)
Stage II (1994
-
1998
)
: further convergence of policies
and by creation of a transitional entity, the European
Monetary Institute, to plan the move to a monetary
union

3)
Stage III (
starting in 1999
)
: monetary union itself

European Economic and

Monetary Union


Stage III:



Austria, Belgium, Finland, France, Germany, Ireland, Italy,
Luxembourg, Netherlands, Portugal and Spain join the EMU
in 1999


Greece joins in 2001


Slovenia joins in 2007


Cyprus and Malta join in 2008


Slovakia joins in 2009


Denmark, Sweden and United Kingdom refused to join


Estonia joined in 2011


Potential new members (no exact date can be given due to the
current Eurozone crisis):


Lithuania (previous target 2010)


Poland, Latvia and Czech Republic (previous target 2012)


Hungary (previous target 2013)


Romania (2014)


Bulgaria (2015)

The Crucible of Integration


Collapse of centrally
-
planned system had the biggest
impact on Germany where there was immigration from
the East


Germany proposed reunification of both Germanys


the
Soviet Union was not in a position to object


Eastern Germany came under Western Germany's wing


Living standards were lower in the East, there was outdated
infrastructure and equipment


In 1991 the new lander accounted for 20% of Germany's
labor force but less than 7% of its GDP


There was still a strong incentive to migrate west


The East was also cheap labor threatening unions

Germany's Integration


The Bonn Government responded by giving the same
benefits and wages to the East that the West had


This helped to lower migration to West and bring up their
productivity


These transfers of money gave Germany deficits


Germans did not want to pay higher taxes and this led to
higher interest rates since the Bundesbank did not
intervene


Interest rates were hitched due to the pegged exchange rates
of the EMS


this affected all of Europe


Unemployment in the whole continent rose


This turned into a crisis that disrupted the progress of
Europe's integration

Integration in Distress...


Denmark rejected the Maastricht Treaty in a
referandum in June of 1992


This raised the possibility that a monetary union might not
happen


Speculators anticipated that the Bank of England and
the Bank of Italy would respond by cutting their interest
rates and allow their currencies to depreciate (could not
be done before because of the prospect of the monetary
union)


Speculators pounced on their currencies


This drove Italy and England out of the EMS


Their currencies depreciated by 30%

Integration in Distress...


Spain, Ireland and Portugal were also forced to
devalue several times


By 1993 the crisis affected France whose currency
was one of the center currencies of the EMS


The EMS bands were finally widened from 2.25% to
15%


This allowed speculators to retire to the sidelines
and for European financial markets to settle down


Governments again began pursuing the Maastricht
Criteria

Integration in Distress...


Unemployment though was still high


Corporatism was in decline and this caused high
wages and non
-
wage costs


Europe needed to cut hiring and firing costs


Within all of this the Maastricht Criteria began to
mean unemployment for a lot of European
countries

The Collapse of Central Planning


Centrally planned economies broke down completely at
the end of the 1980s


Eastern Europe just could not keep up with the new
technology and production of the West


In order to keep going Eastern Europe had borrowed a
lot of money from the West and the US in the 1970s
(about $70 billion by the end of the 1970s)


This finally led to a debt crisis in 1981
-
82


To pay of its debts and keep its economies going, the
Eastern European countries began to let market
principles creep in


In the end economic freedom and political repression
proved incompatible


Central planning collapsed

Difficulties of Transition


Eastern Europe had a way difficult transition to the
market



Between 1990
-
1992 output and employment
plummetted

Difficulties of Transition

Difficulties of Transition


These countries needed to reallocate resources from
the production of heavy machinery to consumer
goods


they needed to go from manufacturing to
services


Obviously this would bring down output


Western Europe had the same challenge after WWII


The difference was the Marshall Plan


There was no Marshall Plan for Eastern Europe


Liberalization needed to take place to give managers
incentive to make profits and avoid losses

Difficulties of Transition

Difficulties of Transition


Radical transition happened



The front runners in the transition were Hungary,
Poland and Slovenia

Europe in the 21
st

Century


In economic sense Europe in 1948 and Europe
today look very different

Links between Europe of
Yesterday and Today...

1)
Shift to intensive growth

2)
Governments increased spending and hiring to
keep
labor

happy now leading to massive
unemployment and higher taxes

3)
Regional integration

4)
Major financial crisis

Based on Benjamin Cohen’s article “Monetary
Governance in a World of Regional Currencies”

Deterritorialization of Money


Circulation of national currencies no longer
coincides with territorial boundaries of nation
-
states


Dollar and Euro used widely outside their origin
competing directly with local currency for both
transactions and investment purposes


Called currency substitution (effect of globalization)


Before there was a monopoly of currency now there
is an oligopoly


Another alternative has been to replace national
currency with a regional money

Currency Regionalization


Currency Regionalization occurs when two or more
states formally share a single money

1.
Currency Unification
: Countries merge their separate
currencies into a new joint money (ex: EU and the
Euro)


ALLIANCE

2.
Dollarization
: Any single country can unilaterally or by
agreement replace its own currency with an already
existing other currency (ex: Monaco, Panama, Ecuador,
El Salvador)
-

FOLLOWERSHIP

Darwinian Struggle of Currencies


The number of currencies in the world is declining


Although not all national currencies will dissapear
due to national pride

1.
Currency Unification
: Monetary Sovereignty is pooled
(ex. ECB)

2.
Dollarization
: Monetary Sovereignty is surrendered
(ex. Countries following the US $)

Currency Choices

1)
Traditional Sovereignty

2)
Monetary Alliance

3)
Formal Subordination



Economic globalization is leading nations to
reconsider traditional monetary sovereignty

Currency Regionalization


50 years ago, national monetary systems were
generally insular and strictly controlled



In the 1950s barriers separating local currencies began
gradually to dissolve


This was partly due to increased trade


Facilitated increased flow of funds between states


It was also partly due to increased competition,
technology and innovation


Currency substitution began to take hold


Currency Regionalization


Capital mobility


another effect of globalization


Led to the integration of financial markets



Money is now being used in many different ways:


Store of value


Investment medium


Medium of exchange

Currency Regionalization


Foreign currency notes in the mid
-
1990s accounted
for 20% or more of the local money stock in as many
as three dozen (~36) nations inhabited by one
-
third of
the world population


25%
-

one
-
third of the world’s money supply is now
located outside its country of issue


Currency substitution is most popular in:


Latin America, Middle East, Former Soviet Union states


favor the US $


Balkans, East
-
Central Europe


favored the DM and now
the



Currency Substitution


By the mid 1990s there were at least 18 countries that
had 30% of their money supply in another currency



Most extreme cases (over 50%):


Azerbaijan, Bolivia, Croatia, Nicaragua, Peru and
Uruguay



Another 39 countries were approaching the 30% level
indicating “moderate” penetration

Currency Substitution


Some economists wonder how this will affect FX rates


Traditionally FX
:


Fixed Exchange Rates


Single Currency


Basket of Currencies


Flexible Exchange Rates


Managed


Left to the market of supply and demand


Recently FX
:


Contingent Rules


“Corner Solutions”


Free Floating


Monetary Union


Irrevocable (Currency Board)


Target Zone

Currency Regionalization


More is at stake than FX rates



The real question is of national monetary sovereignty



Economic actors are no longer restricted to a single
currency and this has led to a sort of currency
competition

Currency Regionalization


5 main benefits of a strictly territorial currency:


1.
Potential reduction of domestic transactions costs to
promote economic growth

2.
A potent political symbol to promote a sense of national
identity

3.
A powerful source of revenue (seigniorage) to underwrite
public expenditures

4.
A possible instrument to manage the macro
-
economic
performance of the economy

5.
A practical means to insulate the nation from foreign
influence or constraint

Seigniorage

Seigniorage
, also spelled
seignorage

or
seigneurage
, is the net
revenue

derived from the
issuing of
currency
. It arises from the difference
between the
face value

of a
coin

or
bank note

and
the cost of producing, distributing and eventually
retiring it from circulation. Seigniorage is an
important source of revenue for some national
banks
.

Currency Regionalization


All of these are eroded when a government is no
longer able to exert control over the use of its money



So policymakers are forced to compete for the
allegiance of markets agents to sustain and cultivate
market share for their own brand of currency

Currency Regionalization


Four Strategies are Available:


Considerations:


Policy is defensive (preserve market share)


Policy is aggressive (promote share)


Policy is unilateral


Policy is collective


1.
Market Leadership


Aggressive, unilateralist policy intended to maximize the use of
national money


Predatory price leadership

2.
Market Preservation


Status
-
quo policy intended to defend a previously acquired
market position for the home country

Four Strategies (cont.)

3.
Market Alliance


Collusive policy of sharing monetary sovereignty in a monetary
union of some kind


4.
Market

Followership


Policy of subordinating monetary sovereignty to a stronger
foreign currency via a currency board or full dollarization


Passive price followership



Strategy of
Market Leadership

only available to countries
with the most widely circulated currencies ($,

, Yen, ...)



For other currencies only the other three choices remain

Currency Regionalization


The question is: What constraints on national policy are
states willing to accept?



Market Preservation
: Keep their traditional monetary
sovereignty


Many states still choose this route regardless of how uncompetitive
their currency may be



Monetary Alliance
: Join a union and delegate some of that
authority



Market Followership
: Give up all monetary sovereignty


“Produce their own money or buy it from someone else”

Currency Regionalization


Monetary Sovereignty can be defended with tactics of:


Persuasion
: trying to sustain demand for a currency by
supporting its reputation



Coercion
: applying formal regulatory powers of the state
to avert any significant shift by users to a more popular
foreign money


Ex: laws that dictate what money creditors can accept for debt,
limits on foreign currency deposits, exchange restrictions

Defending Monetary Sovereignty


These tactics can become expensive as currency
competition accelerates


May lead to less growth and more unemployment


Due to this, many countries have begun to consider the
solution of a monetary union either in the form of:


Dollarization: (ex. Latin America)


Not difficult to imagine two giant monetary blocs (US and EU and
maybe possibly Japan as a third bloc) due to increased dollarization


Currency Unification (ex. EU)


Much will depend on the policies of the market leaders
and will alter the costs and benefits of followership

Benefits of Monetary Leadership


Additional opportunities for Seigniorage



Enhanced degree of macroeconomic flexibility



May yield dividends in terms of power and prestige



This could lead US
-
EU
-
Japan to offer incentives to
potential dollarizers



Risks of Monetary Leadership
:


Policy constraints to consider the needs of followers

Monetary Decisions


Another option is to join a currency union


Examples are the EMU, CFA Franc Zone in Africa, Eastern
Caribbean Currency Union (ECCU) in the Caribbean



EMU is a test of pooling rather than surrendering
monetary sovereignty

The Rise of Currencies...


Presently there are more than 170 central banks in the
world


100 years ago there were fewer than 20


If there are more than 100 currencies could this really
lead to stability?


Some economists argue that regionalization of
currencies is a no
-
brainer


Policy Considerations


Alliance or Followership?



Will depend on:


Issuing of Currency


Management of Decisions

Currency Issue


Highest degree of currency regionalization is when a
single money is used by all participating countries



This is the way dollarization works



Ex. Lichtenstein and Micronesia



EU and ECCU are other examples

Fully Dollarized Countries

US $

US Virgin Islands,

Caribbean
Netherlands, El Salvador, Marshall
Islands, Micronesia, Palau, Turks and
Caicos

Euro


Andorra,

Kosovo, Montenegro, San Marino,
Vatican City, Monaco

New Zealand $

Niue, Pitcairn Islands, Tokelau

Australia

$

Nauru

South African Rand

Swaziland,

Lesotho, Namibia

Others

Armenian Dram


Nagorno Karabakh
;
Russian Ruble


South Ossetia and
Abkhazia; Indian Rupee


Bhutan and
Nepal; Swiss Franc


Lictenstein; Israeli
shekel


Palestenian territories; Turkish lira


TRNC;

Currency Issue (cont.)


Parallel circulation of two or more monies (still
dollarization)


Ex. Panama uses US $ and locally issued coins
(Panamanian balboas)


Near
-
dollarized countries


foreign currency
dominates domestic money supply but falls short of
absolute monopoly


Lower degree of dollarization than full dollarization

Near
-
Dollarized Countries

Country

Currency Used

Since

Local Currency

Ecuador

US$

2000

Sucre

El Salvador

US$

2001

Colon

Kiribati

Australian $

1943

Own coins

Panama

US$

1904

Balboa

Tuvalu

Australian

$

1892

Tuvaluan

dollar

East Timor

US$

Own coins

Cook Islands

New Zealand

$

Own coins

Currency Issue (cont.)


Even lower degree of dollarization


Currency Board


Home money accounts for a large part of domestic
money supply however its issue is firmly tied to the
availability of a designated foreign currency


referred
to as “anchor currency”


The exchange rate is fixed between the two countries


Both currencies circulate as legal tender


Any increase in local money supply should be backed
by an increase in the reserve holdings of the anchor
currency


Ex.
Bulgaria,
Lithuania (Argentina was of this group
until the collapse of 2002)

Currency Board

Country

Anchor Currency

Since

Local Currency

Bermuda

US$

Bosnia and
Herzegovina

Euro (formerly DM)

1998

Bosnian

marka

Brunei Darussalam

Singapore dollar

1967

Brunei dollar

Bulgaria

Euro (formerly DM)

1997

Lev

Cape Verde

Euro

1999

escudo

Cayman Islands

US$

Comoros Islands

Euro (formerly FF)

1979

Comorian franc

Denmark

Euro

1999

Danish

Kroner

Djibouti

US$

1949

Djibouti franc

Hong Kong

US$

1983

Hong Kong dollar

Latvia

Euro

2005

Lat

Lithuania

Euro (formerly US$)

2002

Litas

Macao

Hong Kong $

Morocco

Euro

1999

Dirham

Sao Tome e Principe

Euro

2010

Dobra

Currency Issue (cont.)


Lowest Degree of Dollarization


Bimonetary
Relationships


Legal tender status is extended to one or more foreign
monies but without the formal ties of a currency
board


Local money supply is not dependent on availability
of anchor currency


Exchange rate is not irrevocably fixed


Ex. Bhutan, the Bahamas

Bimonetary Relationships

Monetary Alliance


Parallel circulation of 2
or more currencies is
also consistent with a
monetary alliance