M C P : W

MACROECONOMIC COORDINATION POLICIES: WHY AND HOW
FROM EUROPE TO MERCOSUR
Diego Moccero1 and Carlos Winograd2
Preliminary Version3
June 30, 2005
I. INTRODUCTION..................................................................................................................................... 2
II. WHY DID EUROPE COORDINATE? HOW THEY DID IT? .......................................................... 4
II.A. THE BRETTON WOODS SYSTEM AS A COORDINATION MECHANISM .................................................... 5
II.B. THE BEGINNING OF MONETARY COOPERATION ................................................................................... 6
II.C. THE MONETARY SNAKE ..................................................................................................................... 7
II.D. THE EUROPEAN MONETARY SYSTEM (EMS)..................................................................................... 9
II.E. THE MAASTRICHT TREATY .............................................................................................................. 14
II.F. CRITICS TO THE EMS AND THE MAASTRICHT TREATY ..................................................................... 18
III. LESSONS FOR MERCOSUR..............................................ERROR! BOOKMARK NOT DEFINED.
IV. WHY COORDINATING MACRO POLICIES IN MERCOSUR? ................................................ 25
IV.A. INTERDEPENDENCE AND OCA IN MERCOSUR ................................................................................ 25
IV.B. FINANCIAL CRISIS AND CONTAGION ................................................................................................ 33
IV.C. EXCHANGE RATE AND INTRA REGIONAL TRADE .............................................................................. 35
V. WHAT SHOULD BE COORDINATED IN MERCOSUR?.............................................................. 36
V.A. GOOD STARTING POINT: MACROECONOMIC BEHAVIOR OF MERCOSUR COUNTRIES ......................... 38
V.B. THE EXCHANGE RATE POLICY .......................................................................................................... 42
V.C. PREVENTING FINANCIAL INSTABILITY AND CONTAGION .................................................................. 46
V.D. THE DESIGN OF ENFORCEABILITY MECHANISMS TO MAKE COUNTRIES RESPECT THE COORDINATION
POLICY RULES ........................................................................................................................................... 48
VI. CONCLUSION: REVERSING EUROPEAN MONETARY INTEGRATION ............................. 50
1
DELTA-ENS, Paris.
EPEE, University Paris-Evry and DELTA-ENS, Paris.
3
We thank the support of the Inter-American Development Bank and participants at the Washington
Seminar on Deepening Mercosur in February 2005. All errors remain ours.
2
1
I. Introduction
The macroeconomic coordination initiative in Mercosur has been very limited until now.
This is the case even if the Mercosur has among its foundational objectives the
coordination of monetary, fiscal and exchange rate policies (Integration Cooperation and
Development Treaty, 1988).
As it is widely discussed in the literature, macro policy coordination may have
costs and benefits that should be carefully analysed before advancing in the cooperation
process. To perform this task, two brands of literature are usually considered. The first
one is that of the Optimal Currency Areas (OCAs), which stresses the conditions under
which it would be beneficial for a country to abandon (or loose degrees of freedom) his
exchange rate policy (monetary policy) as an instrument of economic adjustment. The
second line of work is that of the Credibility Gains, which holds that it could be
beneficial for a country to peg its currency to a low inflation country in order to “absorb”
its credibility.
Other relevant arguments going from interdependence to contagion, unaccounted
for in the aforementioned theories, should be considered in the decision making process
leading to macroeconomic cooperation among nations. One has to do with the costs that
interdependent countries have to face in light of possible macroeconomic disturbances in
members countries. It would then be in the interest of these countries to coordinate their
policies in order to avoid “contagion” effects and eventually, to reduce such turmoil.
Integration in trade and assets raises the level of interdependence between economies,
thus reinforcing the transmission of shocks between countries. The need to coordinate
macroeconomic policies to prevent or diminish the negative impact of shocks will then
emerge.4On the other hand, if greater integration in trade and financial markets may be
welfare improving a more stable macroeconomic environment between the partners of
the international economy will in turn reinforce the incentives for deeper integration. This
argument goes way back into the controversies on the preferred international monetary
regime. Whereas in the gold standard days and later in the views of JM Keynes leading to
the Bretton Woods agreements that followed the experience of the collapse of
international trade and finance in the chaotic 1930s. A virtuous cycle of cooperation and
welfare improving interdependence may thus result.
On the other hand, there are also political economy considerations that may drive
the process, as was the case in Europe. For centuries, that continent was the scene of
frequent wars. In the period 1870 to 1945, France and Germany engaged in three major
military conflicts, with ever rising human casualties and material destruction. At the end
of World War Two, western world leaders developed the conviction that the only way to
secure a lasting peace and economic progress was to increase interdependence between
the long time rivals. The role of these priors explain in several occasions of economic and
political tensions the resulting outcomes in the last forty years. In 1950 and as a first step
in the integration process, the French Foreign Minister Robert Schuman proposed
4
Coordination may reduce the possibility of a crisis by imposing limits to fiscal deficits and debt, favoring
cross country economic surveillance, etc.
2
integrating the coal and steel industries of Western Europe. As a result, in 1951, the
European Coal and Steel Community (ECSC) was set up, with six members: Belgium,
Luxembourg, Netherlands (Benelux), France, Italy, and West Germany.
In the case of Mercosur, international shocks as well as national economic
disturbances and the effects of contagion have been significant in the last twenty years. In
the course of the process of trade integration starting in the 1980s these countries have
become increasingly interdependent and the transmission of economic shocks in the
region play an increasing role in their macroeconomic performance.5 If military
considerations have a minor importance compared to the European experience, we should
not neglect that in the traditional hypothesis of conflict of the military strategists the
Mercosur countries were rivals since independence6 and as recently as 1978, Argentina
and Chile (associate member) under dictatorships, were a few hours away from open war.
On the other hand, the Mercosur agreement has particular clauses on the common goal of
sustaining democratic regimes in the region. In the face of political crisis in Paraguay the
bloc diminished the risks of a military coup in the 1990s.
Given the relatively lower political incentives for interdependence in Mercosur
than in the European experience, economic disturbances and economic lobbies may
prevail in times of crisis increasing the risks of derailing the integration process. Abrupt
changes in bilateral real exchange rates, as well as divergent economic cycles may have a
strong negative impact on certain sectors of the economy and society, leading to
pressures for protectionist measures or distortive policies. In the current situation of
Mercosur, marked by confusion and paralysis, aiming at relatively stable real exchange
rates, based on consistent fundamentals, may contribute to contain the political gains of
protectionist rhetoric and lead to deepening integration.
But the will to foster integration through cooperation cannot neglect the
fundamentals of the club of countries involved. The disparities between the economies of
the region are significant: in terms of size, income per capita (among countries and
domestic inequality), trade openness, economic structures, institutional development and
social indicators. These important disparities may have a strong negative impact on the
potential for regional macro coordination. Excessive differences between the countries
may impinge coordination by requiring unequal treatment of countries and groups in the
face of adverse conditions, such as asymmetric shocks. In turn, these disparities in
various dimensions and the resulting responses will produce unequal benefits of policy
coordination. Thus one of the main challenges for regional economic policy lies in the
design of the coordination strategy bearing in mind the fundamental disparities identified.
Can macro coordination contribute to convergence in the relevant dimensions above
quoted? We will discuss the potential benefits of cooperation focusing on what should be
coordinated.
This paper contains six sections. The second, discusses briefly the coordination
experience of the European Union, whereas the third section draws the main lessons for
5
For an analysis of trade specialisation and the relationship between the two major partners in the block,
Argentina and Brazil, see Miotti, Quenan and Winograd (1995, 1999 and 2004). Carrera et al. (1998) show
that a shock to one country has a greater impact on the other in the 1990s than in the 1980s.
6
See Potash (1969) and Rouquie (1978).
3
the Mercosur. We will discuss the European experience of macroeconomic coordination
since the early days of European Economic Community. Exchange rate coordination was
a main characteristic of the coordination process in that region. As such, we will analyze
the monetary snake and the European Monetary System (EMS) and we will evaluate the
critiques to these schemes. The fourth section addresses the arguments for
macroeconomic coordination in the Mercosur going from the role of interdependence and
the theory of optimal currency areas (OCA), as well as the impact of frequent financial
crisis and contagion problems in the Mercosur perspective. The fifth section discusses the
macroeconomic coordination strategies in the South American common market, stressing
the current conditions concerning exchange rate regimes, public finance, public debt,
inflation, as well as political economy arguments relevant for the cost-benefit analysis of
policy coordination. The sixth section contains the conclusions.
II. Why did Europe coordinate? How they did it?
The European case is the most important one to be analyzed in order to get insights on
the theory and practice of macroeconomic coordination policies for other regions of the
world. This process proceeded in steps, increasing from a low to a high intensity of
coordination. Also, the coordination effort has been a long and difficult process dealing
with countries of diverse economic status and institutional set ups, developed under
changing international scenarios. Economic and monetary crisis were not absent with
frequent ups and downs in the process that eventually led to the creation of the monetary
union. In the course of this long period ending in the successful launch of the common
currency the strategy and the policy choices adopted were often the subject of severe
criticisms, in particular in the most recent phases preceding the creation of the euro (the
European monetary system –EMS- and the Maastricht treaty). As will be seen in the next
sections, the main controversies concerned the possibility of maintaining long lasting
pegged exchange rates, the conception of the system-wide monetary policy and the
convergence criteria for interest rates, inflation and fiscal targets. It should be noted that
most of the arguments against the course of action chosen were coherent and robust from
an economic perspective, but the road to monetary union proved to be rather harmonious.
What was then right been possibly wrong? What is the relevance of these controversies
for the analysis of macroeconomic coordination in the Mercosur?
In this section we will discuss the experience of the European Community and
draw the fundamental lessons, with a particular focus on the monetary issues. Some of
the topics covered will include: the Treaty of Rome at the end of the 1950s, the woks of
the Bretton Woods System during the 1960s, the Werner Report (beginning of the
1970s), the monetary snake of 1972, the European Monetary System of the late 1970s,
the Delors Report and the Maastrich Treaty (the end of the 1980s and beginning of the
1990s, respectively).
The analysis will be conducted in two levels. On the one hand, we will present the
macroeconomic performance of the EEC countries since the 1960s and the particular
actions taken in conducting the coordination (the exchange rate policy and bands widths,
fiscal targets, etc.). Many important questions emerge naturally when analyzing the
European experience: What were the fundamentals of the macroeconomic coordination
4
in Europe? What policies have been coordinated? What where the most important
disparities between countries at the start of the coordination initiatives? Did these
disparities impinge macroeconomic policy coordination? If so, how did they deal with
these disparities? On the other hand, and not less important, we will discuss the
institutional arrangements developed to conduct the coordination policy. Some important
questions should be considered: Which institutions have been created in order to manage
the macroeconomic coordination? How effective were they? Which rules or mechanisms
were implemented to prevent strong deviations of the member countries?
In this section we will initially discuss the history of macro coordination since the
early days of the EEC. The coordination process in Europe proceeded in steps, evolving
from a low to a high intensity of coordination. As already mentioned the macro
coordination showed regular ups and downs in its development due to domestic as well as
international events. We will briefly discuss the various crisis confronted by the set of
countries involved in the coordination initiatives to accomplish the programs proposed.
We will then study the controversies on the different common initiatives, in particular the
EMS and the Maastrich Treaty, the basic architecture leading to the monetary union. The
last part of this section will draw the most important lessons that can be obtained from the
European experience for the Mercosur highway of macro coordination.
II.A. The Bretton Woods System as a coordination mechanism
By the beginning of the 1960s, the coordination concerning the exchange rate policy in
Europe was conducted via the IMF under the Bretton Woods system (BWS). This was a
quasi fixed exchange rate system which linked all currencies to the US dollar and the
latter anchored on a fixed parity to gold. Changes in the parities were allowed only in the
case of a “fundamental disequilibrium” of the balance of payments, while temporary
disequilibria could be financed through credits from the IMF. A 1% band of fluctuation
around the central parities against the US dollar were allowed by the IMF rules. As this
was considered excessive by the European countries, they jointly agreed to limit the band
of fluctuation for their currencies against the dollar to 0.75% in order to reduce the intraEuropean exchange rate volatility. In practice, bilateral exchange rates were stable and
the BWS led the European countries to attain almost completely fixed exchange rates
during most of the 1960s.
From the point of view of the overall process of integration, the decisive event by
that time was the signing of the Treaty of Rome (in the late 1950s), which contained two
chapters concerning the economic policy coordination and the balance of payments. In
particular, it was maintained that the state of the macroeconomy and the exchange rate
policy of every country were considered a matter of common concern. However, these
provisions of the Treaty were never applied in practice since the policy concerning the
exchange rates and the balance of payments assistance were considered a domain of the
IMF. The only important practical consideration regarding macroeconomic policy
coordination embodied in the treaty was the creation of the Monetary Committee. This
was formed mainly by representatives of the Central Banks and of the finance ministries
5
of every member country and it was considered a useful place to exchange information
(Gros and Thygesen, 1998).
Later on, other committees dealing with economic policy coordination were
established. In 1960 the Committee for Conjunctural Policy was set up and in 1964 the
committees for Medium-Term Economic Policy, Budgetary Policy and the committee of
Governors of the Central Banks of the member countries were created. Since the 1960s
was a relatively favorable period where the levels of unemployment and inflation were
low, there was little need for strong government intervention to stabilize the economy.
From this point of view, the stabilization of exchange rates did not imply that any
important domestic policy target should be sacrificed. On the other hand, trade
integration among EEC members was not strong diminishing the role and benefits of
macro coordination. However, we should note that during the 1960s gradual pressures for
the appreciation of the mark were building up and Britain, not yet a member of the EEC,
suffered a series of balance of payments crisis and corrective devaluations under the
assistance of the IMF. Simultaneously, the Triffin problem of confidence in the dollar
was developing, eventually leading to the crisis of the rules of Bretton Woods in the early
1970s. This paper contains
II.B. The beginning of monetary cooperation
Towards the end of the 1960s, two important goals in the European integration process
were completed: the customs union and the establishment of the Common Agricultural
Policy. It therefore seemed time for a further move forward. By the end of 1969, the
German Chancellor Willy Brandt suggested that member states should, in a first phase,
jointly formulate medium-term objectives and aim to harmonize short-term policies. In a
second phase, the EEC economies could move to a monetary union with permanently
fixed exchange rates. It was then agreed by the countries that a major study should be
conducted on these topics.
By October 1970, a detailed report was issued (called the Werner report)
describing how Europe could reach in three stages a monetary union by 1980. This was
the first time that the project of a common currency was mentioned as an official goal of
the European Economic Community i.e. thirty years before the creation of the euro. In
the first stage, the goal was the reduction of fluctuation margins between the currencies
of the Members States. In particular, the report suggested that the bilateral fluctuation
margins be reduced from the 0.75% agreed under the BWS to 0.6%. Then (second stage),
the European economies should engage a process of total liberalization of capital
movements with the integration of the financial markets and, in particular, of the banking
systems. Finally, the exchange rates between the different currencies should be
irrevocably fixed. Monetary union implied “the total and irreversible convertibility of
currencies, the elimination of fluctuation in exchange rates, the irrevocable fixing of
parity rates and the complete liberalization of capital movements” (The Werner Report,
pp 26).
This report does not include particular propositions concerning the institutional
framework needed to put in place this union. A community system for the central banks,
based on the the US Federal Reserve System, is suggested to conduct the monetary policy
6
and exchange-rate policy vis-à-vis third currencies. The Werner Report adressed the
management of fiscal policies, highlighting the need for a “center of decision for
economic policy” that would have a decisive influence over the economic policy of every
country, including national budgetary policies. In particular, it was stated that changes in
the public budgets, the size of balances and the financial policies should be agreed at the
Community level.
The Report did not have specific references to the procedures and the
macroeconomic policy coordination necessary to achieve the monetary union. This can
be explained by the economic performances of the member states of EEC during the
1960s, where these countries showed a low degree of divergence in inflation and other
macroeconomic indicators.
The Werner report was never implemented, even if the goal of a monetary union
for Europe was politically endorsed by member countries. The reasons were twofold
(Gros and Thygesen, 1998). On the one hand, the creation of new institutions (like the
center of decision for economic policy) outside the existing framework was not accepted
by country members. On the other hand the international scenario will strongly
deteriorate in the 1970s with the collapse of the rules of the Bretton Woods System and
the first oil shock in 1973. Inflation and unemployment will now emerge as new
challenges for economic policy generating tensions in the EEC due to different policy
preferences of the country members. The plans for the EMU, established in the Report,
were then neglected.
II.C. The Monetary Snake
The Werner report was never implemented as such, but it should be noted that many of
the goals and ideas presented were undertaken later. In particular, it should be highlighted
the emphasis of the report on the coordination of macroeconomic policies. For instance,
concerning monetary policy the Committee of Central Bank Governors was to establish
general guidelines for member states, on issues such as bank liquidity, the terms for
supply of credit and the level of interest rates. In practice, however, policy coordination
concerned only the day to day management of the foreign exchange market (Gros and
Thygesen, 1998).
On the other hand, the EEC countries followed the fundamental views of the
Werner report aimed at preserving a stability in European exchange movements. With
this objective was created the Monetary Snake in 1972. Under the new system, every
currency of the six member countries (Belgium, West Germany, Luxembourg, France,
Italy and the Netherlands) was allowed to fluctuate until +/-2.25% against the dollar
(4.5% against each other).
Shortly after the launching of the Monetary Snake, Denmark, United Kingdom,
Ireland and Norway joined the EEC ant its six original member countries. To ensure the
proper operation of the snake mechanism, the member states created in 1973 the
European Monetary Cooperation Fund (EMCF) which was authorized to receive part of
the national monetary reserves. The Fund settled intervention balances and provided
7
short-term balance of payments support (by providing short term and very short term
facilities to the countries). Initially, this Fund existed more on paper since all operations
were performed by the Bank of International Settlements (BIS) acting as agent.
In the environment of growing uncertainty due to collapse of the Bretton Woods
rules in 1972, the system was put under severe pressure with the oil shock crisis of the
early 1970’s. Member States’ currencies fluctuated sharply, with some countries going
out and back into the system (Denmark and France) and other economies leaving it
altogether (United Kingdom and Italy). For the countries that stayed in, individual
realignments in exchange rates were frequent, while other countries let their exchange
rate fluctuate temporarily. The case of France is paradigmatic in this respect since it
showed until which point there was a divergence in policy preferences with Germany.
While the latter country never left the system and managed to control inflation, France
abandoned the snake exchange regime twice (1973 and 1976) to engage in more
expansionary policies than Germany. The failure of Germany and France to agree on
policy coordination was then apparent.
Later on, a general realignment occurred in October 1976 (the
so called Frankfurt realignment), launching a phase of frequent exchange rate changes.
Overall, five realignments were undertaken between the Frankfurt realignment of 1976
and the end of the snake prior to the negotiations to implement the European Monetary
System (EMS) in the last quarter of 1978. In the second half of the 1970s inflation
showed a sharp increase in Europe, notably so in countries like Italy and England were it
approached 20% per year (Graph 1). The mid-1970s appear in retrospective as a low
point in European monetary integration, marked by tensions in policy objectives (and
preferences) between countries and divergent monetary policies.
In summary, the positive performance expected by the supporters of the Monetary
Snake did not show in the facts. The disruptions provoked by the collapse of the rules set
in Bretton Woods and the sharp increase in oil prices led to non symmetric effects on the
European economies and divergent economic policy responses of the Member States in
the 70s. In turn, increasing volatility induced frequent and sharp fluctuations in exchange
rates. Entry and exit from the exchange stability mechanism became regular economics in
the European arena and the market expectations reinforced destabilizing fundamentals.
The snake mechanism, originally designed as an agreement of Community scope, was
finally (by 1977) reduced to a zone of monetary stability around the German mark, with
only five out of nine member states as participants (Germany, Belgium, the Netherlands,
Luxembourg and Denmark).
8
Graph 1
Inflation in Italy and the UK
0.3
Italy
United Kingdom
0.25
0.2
0.15
0.1
2002
1999
1996
1993
1990
1987
1984
1981
1978
1975
1972
1969
1966
1963
0
1960
0.05
Year
Source: IFS of the IMF.
II.D. The European Monetary System (EMS)
The German Chancellor, Helmut Schmidt, and the French President, Valéry Giscard
d’Estaing decided in 1978 to establish a fixed exchange rate system for the member
countries of the European Union. Academic and public criticism were then widespread.
The new scheme started in March 1979 and operated in its original format – with minor
changes - until the beginning of the European Monetary Union, on January 1, 1999.7
In March 1979, all ten member countries were part of the EMS, but the United
Kingdom and Greece did not participate in the exchange rate mechanism (ERM). Thus,
their membership was of a purely formal nature, except for the fact that their currencies
were included in the new ECU currency basket.
At the start of the ERM the eight members were relatively heterogeneous
countries. Their population varied from 360,000 inhabitants (Luxembourg) to 61,3
million inhabitants (Federal Republic of Germany). The per capita income of the poorest
country (Ireland) was only 58 % of the most wealthy country (Netherlands). The inflation
rate in Italy (14.7 %) was more than three times higher than the inflation rate in Germany
(4.1 %). And while Germany had then full employment (the unemployment rate was 3.2
%), Italy was already confronted with a serious unemployment problem (7.8 %). Major
differences can also be observed in terms of the eight countries’ trade openness: each of
7
Negotiations had started well before 1978 taking place during great part of that decade.
9
the three Benelux countries (Luxembourg, Belgium and the Netherlands) had a degree of
openness (exports + imports as % of GDP) of 50 % and more, while France was a
relatively closed economy (18.3 %).
In spite of these differences, the European countries had common objectives on
exchange rate and monetary policy arrangements (Bofinger and Flassbeck, 2000). In the
1970s inflation was a serious problem for many European countries (Graphs 2 and 3) and
disinflation was an important common objective. Given the high credibility of the
Bundesbank’s monetary policy and the relatively low inflation rate of Germany in 1978,
there was an incentive for the high-inflation ERM members to target a stable nominal
exchange rate with that country. Germany was the best anchor for the European monetary
stability.
The common agricultural policy (CAP) was also an incentive for stable bilateral
exchange rates. For the agricultural sector, the Treaty envisaged a scheme of strongly
regulated common prices (in a common currency) for all member countries. Under the
rules of the CAP short term exchange rate instability had very unpleasant consequences.
In an economic area without trade restrictions and low transport costs, such as Europe,
deviations from the “law of one price” will be very limited. Thus, strongly fluctuating
exchange rates provide opportunities for arbitrage which impair or benefit local
producers in an arbitrary way. In order to deal with this problem a highly complicated
system of “green parities” and compensating payments was created. Thus, the CAP rules
in an environment of highly integrated markets were an additional incentive for exchange
rate stability.
Furthermore, the relatively unsettled European monetary policy was an important
incentive for the common search for exchange rate stability by country members. The
frustrating experience of the monetary snake was at the basis of the new initiative for
monetary cooperation. The snake system started with the six founding members. The UK
and Denmark joined the scheme later, but they stayed in the snake only for a short period.
Norway and Sweden became associated members. After the withdrawal of Italy in 1971,
the two withdrawals of France (in 1973 and in 1976), and a withdrawal of Sweden
(1977), in 1978 the snake included only Germany, the three Benelux states and Norway.
This rather unstable collective performance led to a comprehensive approach to European
monetary integration.
The EMS was the response to this state of dissatisfaction with monetary affairs,
even if we should highlight the initial resistance to the initiative and the low credibility
that it conveyed. The new monetary scheme had two fundamental features. The first was
the establishment of the exchange rate mechanism (ERM), which is by far the most
important characteristic of the system. The core of this mechanism was provided by a
parity grid, a matrix of bilateral exchange rates that determined for each member
currency a parity vis à vis all other ERM currencies. Around this parity a band of ± 2.25
% for most member countries was established (Belgium, Denmark, France, Germany,
Ireland and the Netherlands). Italy was allowed to use a larger band of ± 6 % until 1990,
when it decided to adhere to the narrow band. Newcomers to the system, Spain (1989),
UK (1990) and Portugal (1992) adopted initially the wider band. After the 1992/93 ERM
crises, the band was widened to ± 15 %. The bands constituted for each currency an
upper and a lower intervention point vis-à-vis all other currencies. The symmetry of the
10
bilateral parities implied that whenever a currency A reached its upper intervention point
vis-à-vis currency B (i.e. it depreciated vis-à-vis this currency), currency B
simultaneously reached its lower intervention point vis-à-vis currency A. Thus, if a
currency pair drifts to its bands, there were supposed to be two central banks that have an
obligation to intervene.8
The second important feature of the system was the creation of the ECU, a new
monetary unit defined as a basket of currencies of the countries that are members of the
EMS. The ECU is composed of fixed absolute amounts of the currencies of all nine
member countries which reflected the economic size of each participant in the EMS. The
ECU was supposed to serve four main functions: a) “as a denominator (numéraire) for the
exchange rate mechanism; b) as the basis for a divergence indicator; c) as the
denominator for the operations in both the intervention and the credit mechanisms; and d)
as a means of settlement between monetary authorities of the European Community”. In
practice, however, the ECU’s role in the ERM remained very limited.9
The system had a turbulent start since the occurrence of the second oil shock in
1979-80 put again in evidence important differences in policy preferences in Europe. The
shock did not only lead to an increase of inflation in the EEC economies, but also
worsened the current accounts, output contracted and the unemployment rates rose
sharply (Graphs 4 and 5). The response of the french authorities to the oil shock showed
once again a higher (lower) preference than Germany to overcome the recession via an
expansionary fiscal policy (for tight public finance and price stability). This fundamental
divergence in preferences between France and Germany, that extended to other EEC
countries, explains the exchange volatility (frequent currency realignments, i.e. changes
in the central parities between countries) of the region in the first half of the 80s.10 They
became less frequent since the middle of the 80s and during the 1987-92 period no
realignment at all took place. It is worthy mention that realignments were in general
coupled with local policy measures that tended to offset inflationary pressures, such as
deindexation of the economy, temporary freeze of prices and salaries, control of fiscal
deficits, etc. In general these measures were discussed with the other EMS’ members or
at least informed if it was an urgent situation. The other countries evaluated the economic
situation of the country in terms of external sustainability, inflation, competitiveness, etc.
and gave or not their accord.
The EMS allowed for some progress in the conduct of the community monetary
policy. First, realignments started to be seen as a joint responsibility, contrary to the
experience of the Monetary Snake where individual realignments were the rule. In
particular, realignments had to be endorsed by the Council of Ministers of Economics and
Finance (ECOFIN) or at least, to have the informal agreement of the rest of the countries.
Second, they were considered useful to prevent serious misalignments and to contribute
to better equilibrium. Even if there was not any visible rule on the size of realignments,
inflation differentials were broadly accommodated to contain changes in competitiveness.
8
This formal symmetry of the exchange rate intervention mechanism has led to confusion on the
adjustment process among the member countries. The issue of symmetry versus asymmetry in such a
system will be analyzed in a latter version of the paper.
9
For a more detailed analysis see Bofinger and Flassbeck, 2000.
10
More than ten realignments took place by that time.
11
This was so not only for the EMS period but also after 1993. In any case, we can observe
at the end of the process that led to the common currency that some countries
experienced real appreciations and others real depreciations in their bilateral real
exchange rates with Germany (Table 1).
The operational and institutional set up of the system didn’t change very much
since it was put in place and until the Maastricht treaty in 1992. By this time, a series of
developments chocked the system: apparent overvaluation of some participating
currencies, German unification and the associated distortions in the German policy mix,
doubts about the feasibility of EMU in light of the difficulties of ratifying the Maastricht
treaty in several member countries and the weakness of the US dollar.
Graph 2
Inflation in the EU15 countries
0.18
Median
0.16
Std Dev
0.14
0.12
0.1
0.08
0.06
0.04
Source: IFS of the IMF.
Year
12
2002
1999
1996
1993
1990
1987
1984
1981
1978
1975
1972
1969
1966
1963
0
1960
0.02
Graph 3
EU15 - Inflation differential (with Germany)
0.1
Median
0.08
Std Dev
0.06
0.04
2002
1999
1996
1993
1990
1987
1984
1981
1978
1975
1972
1969
1966
1963
0
1960
0.02
-0.02
-0.04
Year
Source: IFS of the IMF.
Graph 4
GDP Growth in the EU15
0.12
0.1
Median
Std Dev
0.08
0.06
0.04
-0.02
Source: IFS of the IMF.
Year
13
2002
1999
1996
1993
1990
1987
1984
1981
1978
1975
1972
1969
1966
1963
0
1960
0.02
Graph 5
EU15 - Unemployment
14
Median
12
Std Dev
10
Germany
8
6
4
2
1999
1996
1993
1990
1987
1984
1981
1978
1975
1972
1969
1966
1963
1960
0
Year
Source: IFS of the IMF.
II.E. The Maastricht Treaty
The Treaty of Maastricht (1992) introduced new forms of cooperation between the
member states (such as defense, justice, etc.). By adding this intergovernmental
cooperation to the existing Community system, the Maastricht Treaty created the
European Union (EU). It was agreed to engage the process of monetary union (EMU),
leading in time to the introduction of a single European currency managed by a European
Central Bank (ECB).
The strategy set by the Maastrich treaty to reach a monetary union in Europe was
based on two principles. The first proposition was that the transition was seen as a
gradual process, extending over a period of many years. The second principle set in the
treaty required the country members to satisfy a number of convergence criteria before
joining the monetary union.11
Transition was conceived as gradual, proceeding through a succession of stages.
In the first step, which had already started in July 1990, the EMS members abolished all
remaining capital controls and launched a process of increased cooperation among
European Central Banks. During this phase, realignments were still possible. The second
stage started on January 1, 1994. In that year the European Monetary Institute (EMI) was
11
See de Grauwe (1994).
14
created as a transitional step in view of the creation of the European Central Bank (ECB)
and a common currency. The EMI operated only during this phase and was the precursor
of the ECB, with the objective of strengthening cooperation between the national
monetary authorities. In the third and final step (the 1st January 1999), exchange rates
between countries were irrevocably fixed and the ECB started its operations. The ECB,
established in 1998, is in charge of setting the single monetary policy and interest rate for
the nations concerned.
The transition to the final stage is however conditional on the compliance of the
convergence criteria. These criteria must be met by each member state before it can take
part in the last stage of EMU, prior to the creation of the common currency. A country
could only join this third stage if:
•
there was a sustainable degree of price stability and an average inflation rate,
observed over a period of one year before the examination, which did not
exceed by more than one and a half percentage points that of the three best
performing member states in terms of price performance;
•
there was a long term nominal interest rate which did not exceed by more than
two percentage points that of the three best performing member states in terms
of price stability (Graph 6);
•
there wasn’t any devaluation during the two years preceding the entrance into
the union;
•
the ratio of government deficit to gross domestic product must not exceed 3%.
If it is higher than the 3% level, it should have been declining continuously
and substantially and come close to the 3% norm, or alternatively, the
deviation should have been exceptional and temporary and remain close to the
reference value (Graph 7);
•
the ratio of government debt to gross domestic product must not have
exceeded 60%. If it did, it should have diminished sufficiently and approach
the reference value at a satisfactory pace.
Are the Maastrich criteria well grounded?
What was the rationale of these rules? The convergence criteria were meant to
ensure that the macroeconomics within EMU were balanced and did not give rise to
destabilizing tensions between the Member States. In particular, the commitment to
stable exchange rates (no devaluation) was aimed at preventing opportunistic behavior of
governments searching to gain competitiveness before the launching of the euro. Such a
trend could destabilize the road to the common currency leading to a contagion of
competitive devaluations. In other words, Germany aimed at reducing the disparities of
preferences in the monetary region, giving incentives ands discipline devices to induce
convergence to the German benchmark.
In what concerns the criteria adopted for inflation and budget deficits, the main
argument advanced by the Maastrich advocates was that Germany would have been
disadvantaged if it were to form a monetary union with countries which are “less
responsible”. If German preferences are strongly biased in favor of price stability as
15
opposed to employment, and given that the euro-region inflation rate is a weighted
average of member countries, Germany could have suffered a welfare loss if the other
euro partners are more inflation prone (Barro-Gordon, 1983). In turn Germany may have
had strong disincentives to participate in the monetary union, unless it could impose some
entry conditions restrictive criteria) that led the euro outcome closer to its own
preferences.
In the same line of thought we can find the arguments for tight budget rules.
Countries with high levels of public debt (as a % of GDP) could have strong incentives to
inflate and thus melt the debt burden, before entering the monetary union and then ride on
the German credibility (apart from the preferences of the monetary authority). The idea is
that if part of the debt was issued at a constant rate (based on previous expectations of
inflation), an inflationary surprise will reduce its real value. The low inflation country
will thus have a strong interest in obtaining debt reductions, from the high debt partners,
coming from non inflationary adjustments. Indeed, sound public finance was the tool and
the hard constraint on budget deficits coupled with targets on the levels of public debt
were the preferred instruments of the low inflation players. On the other hand, the budget
deficits of the high debt or inflation prone countries are endogenous to the currency
regime. The jump from a low credibility currency such as the Italian lira into a quasiGerman euro leads to a reduction in interest rates on public bonds, thus leading to an
automatic improvement in the budget deficit of the high debt country. The common
currency entry conditions can be then interpreted in the following perspective: before the
union starts, the candidate countries should provide evidence that they accept somehow
the German preferences on price stability, i.e. buying the mark well established
credibility in exchange of forced discipline.
The convergence criteria have been the focus of an intense controversy in the
1990s. As already aforementioned it is interesting to note that, in spite of the robustness
and the well grounded economics of the critiques addressed to the Maastrich strategy, the
inconsistencies and the problems anticipated did not materialize in the facts. These
debates are the subject of the next subsection.
16
Graph 6
Interest rates: EU15 - Government Bond differential (with Germany)
7
6
Median
5
Std Dev
4
3
2
1
2002
1999
1996
1993
1990
1987
1984
1981
1978
1975
1972
1969
1966
1963
-1
1960
0
-2
Year
Source: IFS of the IMF.
Graph 7
EU15 - Fiscal deficit of the central government (as a GDP %)
0.08
0.06
0.04
-0.04
-0.06
Median - EU14
-0.08
Std Dev - EU14
-0.1
Germany
Source: IFS of the IMF.
Year
17
2002
1999
1996
1993
1990
1987
1984
1981
1978
1975
1972
1969
1966
-0.02
1963
0
1960
0.02
II.F. Critiques to the EMS and the Maastricht Treaty
The controversies developed in its time on the road to Maastrich may illustrate important
issues on the economics, theory and facts, of macroeconomic coordination and common
currency strategies. Learning from the European debates yields relevant lessons for the
Mercosur scenarios. The most important problem of the EMS was related to the
credibility of the regime of pegged exchange rates agreed for the transition period on the
way to the common currency system. Another source of concern was the conduct of
monetary policy, i.e. the liquidity problem. These issues led many economists to question
the long run sustainability of the system.12
The credibility problem arises for two different reasons. The first one has to do
with the fact that the exchange rate may often be the less costly instrument for adjustment
in the face of an adverse shock. In such a situation, rational speculators will conclude that
the government has an incentive to change the parity and will thus discount a positive
probability of a devaluation in the future. As a result, the exchange rate commitment of
the Central Bank will not be credible and speculative attacks may thus arise. Grounded
on wrong fundamentals or self fulfilling peg regimes implosions are legion. To overcome
the problem the government in question will have to commit to the agreed fixed exchange
rate, enduring the costs in terms of employment and output. The second source of
credibility concern comes from the disparity in the reputation of the monetary authorities
involved in the exchange rate peg system. Indeed, reputation differentials and the
resulting credibility problems may end undermining the stability of the peg exchange
regime. When a monetary authority marked with the tag of low reputation fixes its
exchange rate, speculators will anticipate a surprise devaluation, leading to higher
inflation and thus obtaining a more favorable output-inflation outcome. Under such
expectations, inflation in the country will be permanently higher, forcing the authorities
to change the parity regularly, i.e. the chronic realignment syndrome. As such, the low
credibility country like this will find very difficult to fix its exchange rate in a credible
manner.
The liquidity problem of pegged exchange rate regimes can be stated as follows:
in an n country system, only one country can fix independently its monetary policy while
the rest of the countries involved in the peg regime have to adjust in order to maintain the
fixed exchange rates. The actions based on this degree of freedom may produce conflicts
of interest between member countries. One possible scenario is that only one country (the
leader) follows a monetary policy fully independent of the other country members. In
such a case, an adverse shock on the other economies (the followers) will be completely
absorbed by the latter, turning the monetary stock and output very volatile in these
countries. Another case scenario may be considered: all the countries concerned decide
jointly the level of the monetary stocks and interest rates in their economies (cooperative
solution). Here, a shock to one country is absorbed by all of them (all the countries
intervene in order to keep exchange rates aligned), minimizing monetary and output
12
See de Grauwe (1994).
18
volatility. In brief, asymmetric systems are not satisfactory regimes to deal with
asymmetric shocks. Asymmetric regimes tend to increase the probability of conflicts
between country members about the pace of monetary policy of the collective system.
More cooperative arrangements will be eventually needed.
We will discuss below the most important criticisms against the Maastricht treaty.
As previously mentioned, the basic rationale of the Maastricht Treaty was that of a
transitory arrangement leading in time to the monetary union. The dominant Maastrich
view was that a successful launching of the common currency required a previous
convergence of inflation, interest rates and budget deficits (and public debt indicators) in
the region, as above stated. Simultaneously it was argued that a gradual increase in the
rigidity of the exchange system was desirable: the proposition finally adopted was that of
establishing fixed exchange rates between country members two years before the
introduction of the EMU. This strategy gave the upper hand to discipline devices in line
with the German concerns (preferences), thus somehow repressing the preferences of
other countries.
This Maastricht strategy for the transition to the monetary union gave rise to
intense controversies among economists. Certain academics such as Giovannini (1990),
Begg et al (1991) and De Grauwe (1994) argued that the Maastricht road to EMU would
jeopardize the objectives of the architects of the monetary union. The most important
critiques were based on diverse economic dimensions. In the first place, these authors
considered that fixed exchange rates would not be sustainable for a long period of time
before the introduction of the common currency. The pressures on the fixed parities
would not only emerge from the different trends observed for the macro fundamentals of
the country members, but also from the conflicts of interest related to the preferred
monetary policy for the region. It was thus argued that these tensions would jeopardize
the credibility of the fixed exchange regime for the transition to EMU, eventually
producing a negative contagion effect on the common currency project.
In turn, the lack of credibility of the fixed parities regime would have made
difficult the convergence in interest rates, one of the Maastrich criteria for entry in the
common currency. Interest rates could only converge in the face of an increasing
confidence that the exchange rates will remain fixed. Thus, the lack of confidence in the
peg system would show in the interest rate differentials among member countries.
The convergence in inflation rates, during the transition phase, was also
problematic given that the national governments would continue to issue their own
currencies. Since the reputation of the monetary authorities differ, expected and actual
inflation may be affected, jeopardizing the desired convergence established by the Treaty.
The public finance rules for entry into the EMU (3 % of GDP of fiscal deficit and
60% of government debt) were also criticized. These criteria were considered
fundamentally ad-hoc, based on a weak economic rationale. Again, one should bear in
mind the monetary conservatism of the German view. There is no fundamental reason to
prohibit a country or a region to have higher levels of public debt. The market parities
should reflect the perception of inter-temporal solvency depending on the expected future
performance of the country. Higher levels of debt may contribute to positive economic
yields for the country in question, thus improving solvency in the future (oil production
19
in country A or better education and increased human capital). But a political economy
argument lies behind the Maastrich view. The countries with soft monetary stands may
try to free ride on the German reputation engaging in excessive debt, eventually
jeopardizing the solvency conditions of their public finance. In the bad scenario, the
probability of financial collapse may arise and in the name of European stability and
regional solidarity pressures for a German (collective) rescue package may be difficult to
contain. Monetary policy of the region may thus become endogenous as well as inflation
rates, and the well behaved countries penalized. Furthermore, a self fulfilling game can
be easily feared. Indeed, the scenario resisted by the German opposition to the common
monetary venture. Thus, the discipline device view embedded in the Maastrich strategy.
The opposition to Maastrich, but favorable to monetary union, believed that the
convergence of exchange rates, interest rates and inflation would only easily occur after a
monetary union was in place. Before that, it was considered hardly viable to meet all of
these criteria simultaneously. Moreover, the conditions stressed by the theory of optimum
currency areas emphasized very different conditions than those of the Maastricht Treaty
(flexible prices and wages, integrated labor markets, automatic fiscal redistribution
mechanisms, etc.). The opinion of the critiques of the Maastricht convergence criteria
was that the strategy was an obstacle to achieve monetary union. But given that the
standard OCA conditions for a common currency were not a disposal, the decision to
engage in the process were based on economic dynamic optimism coupled with political
will, as previously discussed. The strength and fragility of the European currency in the
future may lie in these arguments.
III. Lessons for Mercosur
Three important questions addressed at the beginning of the section concerning
disparities in Europe were the following: What where the most important disparities
between countries at the start of the coordination initiatives? Did these disparities
impinge macroeconomic policy coordination? If so, how did they deal with these
disparities? The goal of this section will be to try to answer this question taking into
account what was said in the preceding paragraphs.
In particular, from the European experience we can infer that disparities in
preferences of the different member states (voters and policy makers) were a very
important characteristic during the whole coordination process. This has been the case
with the snake system in the 70s and the EMS in the 80s and 90s. France and Germany
are a good example of this problem: the former has focused its attention mainly towards
output and employment stability, while the latter has conveyed more weight to inflation
rates. The crisis faced by the EMS in 1993 was strictly connected with the fact that the
recession made it evident that there were non trivial economic policy conflicts among the
countries. It seems then that the existence of marked differences in the preferences of
policymakers in terms of inflation, output and unemployment may jeopardize the
coordination process. How then these countries managed to deal with these disparities?
The answer came from three fronts.
In the first place, it should be remembered that the European integration process
was most of all a political agreement, in response to the collective trauma of wars and
20
massive destruction that took place in that region. This is an important reason why it
could progress through time, even when countries seemed to diverge significantly and
faced frequent crisis (notably, during the 1970s, the 1980s and the speculative attacks of
1992-93). This implies that there should be a great degree of commitment from member
countries towards integration. Also, as suggested by Machinea and Monteagudo (2002),
the process was gradual and involved the mutual trust of the member countries. Lo que
viene de decirse implica un compromiso político que no se encuentra entre los países del
Mercosur hoy en día y que puede llegar a impedir el avance del proceso de integración.
Secondly, they tried explicitly to reduce these disparities by disciplining and/or
repressing them. Concretely, the Maastricht treaty (which is the expression of the winner)
acted as a device that convinced the leader (Germany) to participate in the monetary
coordination initiative, take the role of leader and loose monetary autonomy. This is a key
element when the decisions about the monetary policy (in a monetary union) are going to
be made by member countries through their representation in the union central bank. The
country holding the highest reputation (and the lowest inflation rate) would resist taking
part in a monetary union with less credible countries (and higher inflation rates) as it may
reduce its welfare. Then, in the case of the European Union, Germany (the country with
the best reputation and the lowest inflation rate) solved this problem by demanding the
partner countries to give more weight to price stability. This shift in preferences emerged
in the Maastricht treaty, engaging the member economies in rather restrictive macro rules
on inflation, budget deficits and the national levels of public debt.
We should highlight that the convergence criteria established by the Maastricht
treaty are neither necessary nor sufficient conditions for the existence of a unique
currency. The Maastricht rules are unrelated to the conditions proposed by the theory of
optimum monetary areas (OCA) to obtain an outcome of net benefits from a common
currency strategy. These criteria give incentives for the high credibility country to take
part of the union, thus gaining a low inflation bias for the monetary region. It should be
concluded that a minimum degree of homogeneity in country preferences is a necessary
condition if the system is to successfully survive destabilizing economic events.
In the case of Mercosur, the Germany like country is not a priori in the map.
Which would then be the advantage of a Maastricht - type treaty in Mercosur? As
will be seen later, we could mention the reduction in potential disparities between
countries, in the probability of balance of payment crisis in the region (by means of a set
of constraints for the fundamentals) and financial crisis (rather frequent so far). We
should also consider as a potential benefit of a set of restrictive macroeconomic rules the
decrease in the real exchange rate volatility that leads to the action of disfavored groups
of interest generating increased lobbying and frictions that may block or derail the
integration process.
Finally, it should be pointed out that the international environment plays an
important role in the dynamics of integration and may favor a reduction in preference
disparities. A favorable international environment makes the integration and coordination
process easier. For instance, the high growth rates of the world economy in the 1990s
have certainly had a positive influence on the compliance of the Maastricht convergence
criteria of 1992. Such constraints would have been difficult to attain (as well as political
approval for the agreement) if the world economy had displayed a low growth rate or had
21
been in a recession.13 The favorable international environment of the 1960s with low
inflation and low unemployment rates had also a positive impact on the European
integration process smoothing the road to greater interdependence. On the opposite, when
the international economic scene shows significant disturbances, the voters and policy
makers of the different countries may show divergent responses harming the coordination
effort. This was the case during the 70s and 80s, when the collapse of Bretton Woods and
the severe oil shocks destabilized the macro environment and forced frequent
realignments of the exchange rates as well as many exits and entries of the European
monetary system by country members.
In the case of Mercosur, the impact of the international environment on the
regional economics seems to be even more complex than in the European scenario. The
‘international economy’ may influence a wider set of variables: the international capital
markets, the volatile price of commodities, the international interest rates (when there is
access to the international capital markets), and the growth rates in the developed
countries (important export markets). If the economies of Mercosur, and the region as a
whole, show low degrees of openness the macroeconomic volatility has been very high.
This fact should be certainly acknowledged in the design of coordination policies. The
countries of the region may thus have an incentive to develop joint response mechanisms
against external shocks and design policies to reduce the probability of occurrence of
such shocks (rules on robust public finance, coordination of the banking system
surveillance, etc).
Exchange rate policies have been a key element in the European macroeconomic
coordination initiatives, and it was implemented before other coordination policies (such
as fiscal policies). An important reason why this happened was the significant increase in
intra regional trade.14 The demand for monetary coordination grew then side by side
with intra community trade, whatever this is measured. For instance, from Graph 8 we
can see that exports to member countries (measured by 15 members) as a percent of GDP
grew steadily since 1960. For Germany, we can see that it tripled its weight from 1960 to
the period previous the unification (1989), as it passed from a bit more than 5% to more
than 15%. From that graph we can also see that there are important differences with
France, this country consistently lying before the other. Only towards the end of the
period considered there is a convergence between these nations. The importance of intra
regional commerce is even stronger if one considers the ratio between intra community
exports to extra community exports (Graph 9). Since the beginning of the 60s, exports to
member countries have been greater than those to extra countries for Germany and
France.
Exchange rate coordination and macroeconomic cooperation have not been
smooth ventures in Europe. We have shown that the regional exchange rate agreements
designed have suffered frquent credibility crisis and speculative attacks. If Europe (and
the German anchor) had a hard time in the search for regional reputation, the credibility
13
Note that the present situation of slow growth rates has prevented France and Germany from improving
its fiscal situation.
14
Efforts at macroeconomic cooperation always complemented progress in commercial integration. As
such, interdependence incited coordination but macroeconomic coordination (in exchange rates) facilitated
greater interdependence (Machinea, 2004).
22
challenge for Mercosur is certainly greater. The South American region should expect a
tougher game, with more frequent currency attacks and of larger intensity. The Mercosur
countries should also envisage the development of the appropriate institutional
mechanisms (regional budget policies and intervention fund) for cooperative responses if
coordinated exchange rate policies are launched. In any case, in the face of the wide
credibility gap in the region, buying reputation will require very rigorous and sustained
policy stands. Unless we can find or construct a Latin-German player in short.
Graph 8
Intra EU export as a share of GDP
20
18
Germany
16
France
14
UK
12
10
8
6
4
Source: Gros and Thygesen (1998)
Year
23
1993
1990
1987
1984
1981
1978
1975
1972
1969
1966
1963
0
1960
2
Graph 9
Ratio of intra european to extra euorpean exports
2
1.8
1.6
1.4
1.2
1
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
0
1970
UK
1968
0.2
1966
France
1964
0.4
1962
Germany
1960
0.6
1994
0.8
Year
Source: Gros and Thygesen (1998)
2
1.8
1.6
1.4
1.2
1
Year
Source: Gros and Thygesen (1998)
24
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
0
1970
UK
1968
0.2
1966
France
1964
0.4
1962
Germany
1960
0.6
1994
0.8
IV. Why coordinating macro policies in Mercosur?
In this section we will discuss the fundamentals for macroeconomic coordination in
Mercosur. In view of the theorethical approaches presented in the previous sections and
the European experience we will analyse interdependence and the OCA theory in
Mercosur in the first subsection. In the second, we discuss financial crisis and contagion,
while the third subsection adresses the issue of exchange rate volatility and intra-regional
trade.
IV.A. Interdependence and OCA in Mercosur
Interdependent economies, will be affected by the policies and shocks of other countries.
The higher the level of interdependence the more vulnerable the national economy to the
events in other economies. In an interdependent world, whereas we think about trade or
financial issues, the decision making process of national authorities should take into
account the potential spillovers on, and from, other countries. Collective welfare gains
from coordination may thus arise, as compared to purely autonomous (non coordinated)
policy decisions. In other words, the existence of a process of “agreed decisions” between
countries (policy cooperation), may increase the inter-temporal well being of all the
players.
Thus, the greater the degree of interdependence between nations, the greater will
be the incentives to coordinate macroeconomic policies. An usual measure of
interdependence between nations is based on the trade relations between countries.
Through the channel of intra-regional trade, cycles in one country may be transmitted or
“exported” to the other partners. In the case of Mercosur (Graph 10) the degree of
aggregate interdependence (as measured by the ratio of exports to regional trade partners
over total exports) is low when compared with the EU but also when compared with
other economic regions (NAFTA and ASEAN).15 The degree of regional trade interdependence in Mercosur differs between the four members countries: Brazil has the
lowest intra-regional trade with 8% in 2003, followed by Argentina with close to 20%,
and Uruguay and Paraguay with levels, respectively, of 30% and 60% (Table 2). Exports
as a percentage of GDP also show important disparities going from 1% in the case of
Brazil to 4% for Argentina, 6% and 14% for Uruguay and Paraguay (Table 1). We thus
identify a potential disparity in the incentives to coordinate: the country with the lowest
incentive is Brazil, then followed by Argentina, and the high demand for coordination
would lie in Paraguay and Uruguay. We should highlight a decrease in interdependence
since 1998 with the slowdown of the regional economy on the base of the regional
exports to total exports indicators. This is less so when we observe the exports to GDP
15
As suggested by Miotti, Quenan and Winograd (1998, 2000), Lacunza and Redrado (2003) and by
Lavagna and Giambiagi (2000), the degree of interdependence is higher if one takes into account the
exports with higher value added.
25
indicator. The rebound of economic growth since 2003 may show in a trend of higher
interdependence.
The gains from coordination may extend to other areas than pure economic
decision making. Indeed political economy arguments may again affect the incentives for
cooperation: the geopolitical strategy of Brazil and its will to obtain the regional
leadership from its Mercosur partners may increase its interest in economic coordination,
despite its relatively lower level of intra-regional trade. Lobbying from strongly
(regionally) dependent sectors may as well have an impact on the incentives to
coordinate: in the manufacturing sector in Brazil the degree of intra-regional trade is
high. The pressures for cooperation coming from the firms and regions affected may be
more important.
The theory of optimal currency areas (OCA)
It may be now useful to evaluate the benefits of macroeconomic cooperation or a
monetary union i.e. OCA theory in the view of the economics of Mercosur. Are the
fundamental conditions of an optimal currency area satisfied in this part of the world?
The main benefit of coordination or a common currency would come from the decrease
in transaction costs and the bilateral exchange rate uncertainty (volatility) between the
country members of the region. (quote)
The evaluation of the economic costs of the volatility of regional bilateral real
exchange rates requires an absolute measure of volatility as well as the degree of intraregional interdependence. Intra-regional trade in Mercosur has increased, but is still much
lower than in the EEC in the 1980s when the EMS was launched. On the one hand, given
the lower degrees of trade interdependence, the expected (intra-regional) gains from
exchange rate coordination may be lower in Mercosur than in Europe. But if the long
term stationary interdependence is significantly higher than the observed current values, a
dynamic view on interdependence may give a more positive view on potential gains of
cooperation, as opposed to a static perspective. On the other hand, bilateral real exchange
rate volatility is much higher in Mercosur, presumably leading to positive expected
effects of macroeconomic coordination.16
16
Licandro Ferrando, 2000a highlights that the absolute volatility of the bilateral real exchange rates is
significantly higher in Mercosur than in Europe.
26
Graph 10
Exports to partners as a share of total exports
70.0
ASEAN
60.0
MERCOSUR
%
50.0
40.0
NAFTA
30.0
EU
20.0
10.0
2001
2000
1999
1998
1997
1996
1995
1990
1985
1980
1970
0.0
Year
Source: CEI.
Table 1
Exports to the member countries as a percentage of GDP
Argentina
Brazil
Paraguay
Uruguay
Average
Weighted Average
(GDP)
1993
1.6%
1.2%
4.2%
4.7%
1994
1.9%
1.1%
4.8%
5.1%
1995
2.6%
0.9%
5.9%
5.1%
1996
2.9%
0.9%
6.8%
5.6%
1997
3.3%
1.1%
6.1%
6.2%
1998
3.1%
1.1%
6.1%
6.9%
1999
2.5%
1.3%
3.6%
4.8%
2000
3.0%
1.3%
7.2%
5.1%
2001
2.8%
1.2%
7.6%
4.5%
2002
5.6%
0.7%
9.9%
6.1%
2003
4.4%
1.1%
13.7%
6.0%
2.9%
3.2%
3.6%
4.1%
4.2%
4.3%
3.0%
4.1%
4.0%
5.6%
6.3%
1.4%
1.4%
1.5%
1.6%
1.8%
1.8%
1.8%
1.9%
1.9%
1.8%
2.0%
Source: Calculated using data from CEI.
Table 2
Member country's share in total exports
27
Argentina
Brazil
Paraguay
Uruguay
1993
28.1%
14.0%
39.6%
42.5%
1994
30.3%
13.6%
46.2%
47.0%
1995
32.3%
13.2%
57.4%
47.1%
1996
33.2%
15.3%
62.8%
48.1%
1997
36.3%
17.1%
53.7%
49.7%
1998
35.6%
17.4%
51.7%
55.4%
1999
31.2%
14.1%
41.5%
45.0%
2000
31.9%
14.0%
63.6%
44.6%
2001
28.2%
10.9%
52.4%
40.8%
2002
22.2%
5.5%
58.1%
32.6%
2003
18.9%
7.8%
59.2%
30.6%
Average
31.0% 34.3% 37.5% 39.9% 39.2% 40.0% 33.0% 38.5% 33.1% 29.6% 29.1%
Weighted Average
19.6% 19.8% 19.3% 20.9% 23.0% 23.3% 21.0% 20.7% 17.7% 9.4% 10.8%
(GDP)
Source: Calculated using data from CEI.
The analysis of the sources of excessive volatility should not be bypassed without
discussion. If the major contribution to such volatility lies on certain well identified
macroeconomic variables, the economic policy design could be called to repair these
inefficiencies, thus leading to reduced volatility of the real exchange rate and decreasing
transaction costs (increase in welfare gains). It may be the case, that these economies
show stronger fluctuations in fiscal or monetary policies, or are subjected to frequent
external shocks, etc. On the other hand, we could find that controlling for these
observable sources of real exchange rate volatility, the latter remains very high. If so,
there could be ground for the analysis of policies aimed at reducing volatility, such as
exchange bands or a common currency.
Eichengreen (1998) studies the sources of volatility for a large set of countries,
including developed economies as well as LDCs. The econometric tests include the
impact on real exchange rate volatility of variables such as: differences in country size17,
the disparities in production and trade structures (agriculture, manufactures, minerals,
etc.) 18, the degree of asymmetry of the shocks, trade interdependence between
countries.19 The results obtained show that Mercosur has 60% more volatility than other
comparable economies.
Mercosur and the UE compared we observe a basic twofold evidence. On the one
hand, the former shows lower average intra-regional trade than the latter, even when the
EU started to set the basis for the common currency. On the other hand, the Mercosur
shows a significantly higher volatility of the intra-regional real exchange rate, even
controlling for the observable sources. In view of the disparities of the member countries
the South American regional bloc, the gains from decreasing transaction costs would be
asymmetric. The smaller economies, Paraguay and Uruguay would be the most favored
by increasing cooperation and stability, whereas then would follow Argentina and finally
Brazil.
The theory optimal currency areas also highlights the costs derived from a
common currency. In particular, a cardinal lesson from the OCA theory is that one
17
The smaller the economy the higher the demand for stability, and thus for cooperation.
Sizeable disparities in the production and trade structures may lead to relevant differences in the impact
of sectoral shocks. More flexibility may thus be needed to accommodate such shocks, leading to more
exchange rate volatility.
19
The higher the level of trade interdependence, the stronger the incentives for cooperation and exchange
rate stability.
18
28
important determinant of these costs lies in the asymmetry of shocks between member
countries: if shocks are symmetric, countries will tend to show close reactions – under
weak disparities in preferences (credibility argument). In the case of symmetric shocks
and identical preferences, the incentives to resort to the exchange rate to adjust will be
weak.
Licandro Ferrando (2000a) has compared the degree of symmetry of shocks in
Mercosur with the cases of NAFTA and Europe, finding that shocks are less symmetric
in the Mercosur than in the other regions. Machinea and Monteagudo (2002) also show
that cycles are less synchronous in Mercosur than in Europe. On the other hand,
Bayoumi and Eichengreen (1994) and Kenen (1995) found that the size of shocks is
greater in Mercosur than in Europe. Thus, as of today, we can state that shocks are more
important and less symmetric in the Mercosur countries. But many authors (Carrera et al.,
1998; Giambiagi, 1999; Lacunza and Redrado, 2003; Machinea, 2004) have found that
shocks became more symmetric during the last years, as the integration process has
evolved.
An alternative, if less formal evaluation of the degree of symmetry of external
shocks to an economic region may be based on the evolution of a set of indicators such as
the current accounts, the country (interest rate) risk and the export performance. The
analysis of the current accounts gives an indicator of access to international financial
markets. In the Mercosur during the 1980s (starting in 1982, when Mexico defaulted on
its public debt) in the face of generalized speculative attacks and a sudden stop in capital
inflows, the Latam countries were forced to operate severe (and often chaotic) balance of
payments adjustments. In the early 1990s a sharp turnaround in international capital
markets led to massive inflows into emerging markets. We observe that during this
decade the current accounts of Mercosur countries showed persistent deficits (Graph 11).
Turbulence for emerging economies started to develop in the mid 90s with the Tequila
crisis in Mexico, then followed by speculative attacks in South East Asia, Russia and
Brazil in 1999. Indeed, a new sudden stop in capital flows to the Mercosur coupled with
the severe crisis of the beginning of this century in Argentina showed in a sharp
turnaround in the current account balances of the region in 2003. Sizeable surplus are the
evidence of these days in the Mercosur. We also observe a strong positive correlation for
exports (Graph 12) and for the behavior of the country risk; the latter with a break when
Argentina entered into default (Graph 13), converging to a common regional pattern
more recently. It thus appears that the economies of Mercosur suffer from common
shocks coming from the international environment: trends in export performance, the
capital markets and country risk –including the effect of contagion.
The regular increase in the correlation of shocks and the common impact of the
international environment may indicate that the costs of exchange coordination have
diminished through time. If the region continues on the current path of rising
interdependence, the resulting correlation of the economic cycles may eventually imply
that the OCA conditions for a beneficial common currency option may be satisfied.20
20
Frankel and Rose (1998) have discussed the dynamics of monetary integration and the synchronisation of
economic cycles in the case of developed economies. Indeed, they show that ex-ante the OCA criteria for a
successful monetary union may not be satisfied, but once the common currency is launched one may find
that these conditions are satisfied ex-post.
29
However, there may be limits to the increase in synchrony. The recent study by Calderon,
Chong and Stein (2003) find that the degree of synchronization of economic cycles in
developing economies is lower, thus the (dynamic) effect of monetary integration on
synchronicity may be weak. 21In such a case, even including the positive inter-temporal
impact of a currency union, the common currency strategy may not be a favorable
outcome.
Of course, as established by the OCA theory, asynchronous shocks would not be a
severe problem (leaving aside disparities in preferences) if wages and prices are
flexible, if there is factor mobility and if the authorities can engineer redistributive fiscal
transfers between nations. These are the economic substitutes for adjustment in the
absence of exchange rate: in the first case, the adjustment is made via the prices of goods
and wages. In the second case, factors of production could migrate to the country in
which they are better paid and as such, there is no requirement to adjust relative prices in
order to recover employment. Finally, with inter-country transfers, the economies facing
an adverse shock may receive compensating flows, rendering viable alternative counter
cyclical policies, thus weakening the incentives to resort to an independent national
monetary policy and exchange rate adjustments.
Stein and Panizza (2002) discuss the state and performance of Latin American
labor markets, and conclude that the degree of wage flexibility is not high when
compared with that of developed economies. The assessment is based on comparative
dismissal costs and the persistence of unemployment.22 The imperfect adjustment of
nominal wages to the sharp devaluations and inflation in these countries may call into
question these propositions. We should also reconsider the role of sizeable informal labor
markets in the region.
It should be highlighted that in a region with important wage disparities between
the country members, if the relatively well off country suffers a negative shock its
workers will not have incentives to migrate to the low income country. This will be so in
any regional or national economic environment. But more important, a serious political
economy problem may arise if inter-country labor mobility is to be reinforced. It could be
a source of national and regional political conflict if high income countries are expected
to open its labor markets to the workers of low income countries. This may be
particularly so in view of the tremendous disparities in size. The high income countries
are Argentina and Uruguay, in its metropolitan areas, whereas the low income workers
abound in Brazil and Paraguay. In the face of strong income differentials, a small labor
market with rather more favorable social protection, such as that of Uruguay could have
serious difficulties to cope with important labor flows coming from his northern
neighbor: the population of Brazil is sixty times that of the former.
21
In this paper it is also shown that the impact (synchronicity) is higher in developing countries that are
partners of a regional integration agreement. The authors argue that growing interdependence of LDCs may
have an ambiguous or a negative impact on the correlation of economic cycles: this result may be linked to
the gradual specialization in the production of differentiated goods (inter-industry trade), thus leading to
increase the asymmetry of shocks and reduce the degree of correlation of shocks. If intra-industry trade is
the driving force of specialization the latter proposition should be qualified.
22
Sturzenegger and Levy Yeyati (1999) find that the degree of correlation between nominal wages and
prices is very high in Argentina and Brazil, also concluding that labor markets may not be very flexible.
30
In the case of Europe, it should be observed that the high income countries are the
most populous, whereas the low income tend to be the smaller economies. Indeed, the
typology of income disparity tends to be inverted in terms of size. However, economic
geography may come into the scene to qualify the previous political economy
considerations on labor mobility in the Mercosur. Inter-country income disparity in South
America is important, but also intra-country income differentials are very high. In the
case of Brazil, by far the most populous labor market, income inequality is very
important, with the north of the country weighting heavily on the lower income groups
while the south has income levels equivalent to the richer parts of its southern richer
neighbor countries of Uruguay and Argentina. Migration will thus tend to go the southern
parts of Brazil, with advantages of language, distance and habits i.e. lower barriers to
migration, thus containing potential big population flows to Uruguay and Argentina. In
brief, if as of today regional labor markets were open the political economy risks above
mentioned will be weaker than expected.
In what concerns fiscal redistribution, establishing a regional budget in Mercosur
would be highly controversial in Mercosur these days. First, if we observe that the
correlation of shocks is increasing in the region the demand for compensatory funds will
tend to come simultaneously from various country members, turning redistribution a
difficult exercise. Extreme size disparities would also lead to difficult arbitrages: if Brazil
suffers an adverse shock it is hard to conceive manageable regional fiscal redistribution
coming from the contribution of the smaller partners. On the other hand, national
income inequality would jeopardize the political legitimacy of compensatory fiscal flows
to higher income countries (or regions) based partly on contributions from low income
regions i.e. think northeast Brazil financing the adjustment to an adverse shock in
Argentina.
Summarizing our views on Mercosur based on the OCA theory we obtain some
interesting insights. On the one hand, the degree of commercial interdependence is not
high compared to the current (and early on) European levels, as well as with other trade
agreements. But we should note that intra-regional trade has been increasing, even if
some recent trends show reductions in countries like Uruguay. The transitory and
permanent components of this new pattern is hard to disentangle given the short time
span. From a direct regional trade perspective the welfare gains coming from lower
transaction costs would be weak. On the other hand, the volatility of the real exchange
rate in Mercosur is very high leading to significant transaction costs, thus opening a
window for positive welfare gains from policy cooperation. The costs of coordination
could be important in the face of rather asymmetric and sizeable shocks, as compared to
other regions. If the correlation of shocks in the region seems to be on the rise the
disparities in economic structures among country members suggests that the potential
upper bound (for correlation of shocks) may not be too high. Furthermore, as of today,
the economic (instruments) substitutes for the absence of the exchange rate tool in the
face of asymmetric shocks, are not easily available: price and wage flexibility, and fiscal
redistribution. This may be a static view and a dynamic perspective may yield qualified
results: if the language barrier is weaker in Mercosur than in Europe, the political will
appears to be fundamentally stronger in the latter (despite the recent events). From the
point of view of the OCA theory the case for monetary union does not emerge strongly,
31
at least in the short run. In what follows we will evaluate other (non OCA) sources for
potential gains of macro coordination.
Graph 11
The evolution of current account (% of GDP)
12.0%
10.0%
Uruguay
Paraguay
%
8.0%
6.0%
Argentina
4.0%
Brazil
2.0%
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
-4.0%
1991
-2.0%
1990
0.0%
-6.0%
-8.0%
Year
Graph 12
Exports (1990 = 100)
300
Uruguay
250
Paraguay
Argentina
Brazil
150
100
50
Year
32
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
0
1991
%
200
Graph 13
Country Risk (EMBI)
6000
Argentina
5000
Brazil
EMBI
4000
3000
2000
1000
10/30/2001
4/30/2001
10/30/2000
4/30/2000
10/30/1999
4/30/1999
10/30/1998
4/30/1998
10/30/1997
4/30/1997
10/30/1996
4/30/1996
10/30/1995
4/30/1995
10/30/1994
4/30/1994
10/30/1993
4/30/1993
0
Date
IV.B. Financial crisis and contagion
Speculative attacks and financial crisis were regular news for emerging markets in the
second half of the 1990s. Starting with the Tequila crisis in december 1994 in Mexico,
the fad went to several countries of Southeast Asia in 1997, turning back west to Russia
in 1998, and to Latin America, this time Brazil, again in 1999. Then Turkey followed in
2001, and the mega crisis of Argentina in 2002.
Financial crisis were a distinctive feature of the 1990’s, highlighting the fact that
financial interdependence is deeper than trade interdependence. Indeed, financial
contagion emerged as a fundamental feature of these economies, leading to increased
interest in the study of this issue in emerging economies. In the case of Mercosur,
financial turbulence in a member country may turn into a serious problem for the other
partners of the region. Macroeconomic coordination may help to mitigate the
contamination effects of financial instability.
We have mentioned in the previous section, that from the perspective of trade
interdependence, the smaller countries – with higher levels of regional trade - will tend to
have stronger incentives for macroeconomic coordination. However, when we consider
the role of financial interdependence, the bigger economies may find important incentives
to cooperate, if collective policies contribute to regional stability. Argentine and Brazil
33
were both the sources of financial turmoil in the region. In view of the lessons drawn
from financial instability and contagion effects we will evaluate the costs and benefits of
macroeconomic coordination once again.
The studies developed on the sources of financial and balance of payments crisis discuss
a series of common and idyosincratic factors in the different regions. Among the latter,
the literature highlights the fix exchange rate regimes, contributing to macroeconomic
disequilibria, current account deficits and speculative bubbles in asset markets
(Takatoshi, 2003). Weak financial institutions are another common factor of fragility
shown to be important in twin crisis, financial and balance of payments crisis. In some
cases the turmoil starts in the latter and then contaminates the exchange markets, whereas
in other cases the inverse is true. The banking fragility view emphasizes two important
factors: bad portfolio diversification, showing high exposure in sectors or firms with high
levels of risk, and the maturity and currency mismatch in the banks balance sheets. i.e.
tira colon factor in tease crisis i.e. short run capital flows, with the destabilizing effects
of suden stops and capital flight.23 A difference between the recent events of financial
crisis in Asia and Latin America lies in the role of public finance - unsustainable budget
deficits - and private indebtedness. The former is a distinctive feature in the Latam
experiences, whereas the alter plays a major role in Southeast Asia.24
Fratzscher (2004) discusses the sources of contagion, with a focus on the Mexican (1994)
and Thai crisis (1997). The main question aims at disentangling the role of weak
fundamentals - in the contaminated country – versus herd behavior. It is shown that
unsustainable fundamentals are an important channel of contagion.25 In Asia the fragility
of the financial system coupled with sharp reversions of capital flows play a major role in
the dynamics of crisis, whereas in Latin America the major factor would lie on
unsustainable public policies leveraged by weak banking systems. In both cases the
existence of deep financial and trade relations between the economies is an important
channel of contagion. Indeed, the growing level of interdependence in Mercosur would
reinforce the financial fragility of the region, thus leading to a higher probability of
imported turmoil from the neighbour countries. This would be more true today than in the
early days of regional integration. In turn, this evidence should increase the incentives for
the search of regional stability and for tools of macroeconomic coordination.
In short, the increase in financial interdependence has led to a higher probability
of contagion in emerging economies. Furthermore, the existing evidence tends to show
that deep trade relations between countries reinforce the financial contamination coming
from the international environment at large, as well as from the partners in the
region.26We thus observe that incentives for cooperation in Mercosur may add to the
previously discussed. The major members of the regional trade agreement, Argentina and
23
Agosin (2001) shows that short run capital flows may be excessive relative to the size of the domestic
banking systems, reaching levels of 25% of money supply – as measured by M2.
24
See Hamada (2004).
25
The economic indicators considered are exchange rate arrangements, budget deficits, current account
balances, the size and composition of debt, etc.
26
See Machinea and Monteagudo (2002). The evidence seems to show that the real exchange rate
misalignments between member countries are more significative to explain currency crisis than
misalignments with the rest of the world.
34
Brazil, a frequent source of financial volatility – and both good candidates for financial
epidemics - among emerging economies, may find a new interest to reinforce regional
stability.
IV.C. Exchange rate volatility and intra regional trade
The excessive real exchange rate volatility (intra-region and extra-region)
observed in Mercosur increases the incentives for macroeconomic coordination (or a
credible common currency). It is thus important to evaluate the cost of RER volatility on
variables such as trade, investment and growth. We should also consider the magnitude
of intra-regional and extra-regional exchange rate volatility, as well as the impact of
volatility on intra-regional and extra-regional trade.
Empirical studies on the impact of exchange rate volatility on international trade
are not conclusive, but tend to show a negative effect. It is argued, that in developing
economies were financial markets and hedging instruments (to insure against exchange
variations) are less developed the effect of exchange rate volatility on trade should be
more important (negative) than in richer economies (Devlin et al, 2001).27 We have
mentioned above that on a comparative basis Mercosur shows a much higher degree of
RER volatility than Europe. Indeed, excessive volatility could repress the development of
intra-regional (and extra-regional) trade.
The analysis of macro coordination and exchange arrangements should consider
the impact on trade of intra-region as well as extra-regional RER volatility. If only intra
regional volatility matters, there will be a strong incentive to coordinate intra regional
policies (and exchange rates), and some form of peg in the region may be a good
option.28 Girodano and Monteagudo (2002) show that intra-regional exports tend to have
a stronger response to exchange rate volatility than extra-regional exports. This result
tends to support the idea of coordination between members countries of Mercosur. One
could also consider a regional cooperative policy arrangement that reduces extra-regional
volatility such as a common currency pegged to a basket of world currencies or other
variations on exchange arrangements. In turn, given that it would be a regionally
coordinated rule, regional volatility would also be managed.29
High exchange rate volatility may also increase the activity of protectionist
lobbies, contributing to jeopardize integration and eventually derailing a coherent
strategy to deepen interdependence. Theory and experience have both shown that highly
unstable exchange rates may lead to destabilizing political economy mechanisms.
Devaluation of the currency of a member of regional trade agreement, often the result of
unsustainable exchange appreciation, is perceived as opportunistic behavior and triggers
27
On the case of Latin America see also Machinea and Monteagudo (2002) and Stein and Panizza (2002).
In such a case, Central Banks should maintain foreign reserves in terms of the other’s countries
currencies.
29
These options may call into discussion the potential anchors for the region. In the past it has been
intensively discussed the dollarization (today one could also consider eurization or a basket), but often from
the national perspective. We understand the obvious problem of autonomous dollarization that would leave
fully in place regional RER volatility. A coordinated peg (and variations on this theme) would not suffer
this monetary handicap. It may suffer other handicaps worth being considered.
28
35
protectionist reactions and potentially negative political dynamics for the integration
process. A devaluation may lead to a transitory overshooting of the exchange rate that we
could expect will be followed subsequently a gradual appreciation. In time, a stationary
state will be found with a diminished price differential in favor of the devaluing country,
but overshooting maximizes the transitory handicap of the partners thus giving strong
incentives for protectionist lobbies (employers, workers and politicians). Transitory price
advantages may provoke more permanent (persistence of protectionist measures) trade
barriers, politically costly to remove. The politics of silent winners versus super-active
losers tends to be in motion and may severely affect the integration process. Indeed, this
is a fundamental reason to favor macroeconomic coordination or the adoption of a
common currency in Mercosur.
In the case of Argentina and Brazil, examples abound of sharp changes in the
RER triggering protectionist activity. In the 1990s the real appreciation of the peso led to
a ten per cent statistics import tax in Argentina. In the face of rising current account
imbalances, Brazil imposed in 1997 restrictions and barriers on imports from the
Mercosur partners. And once again in 1999, when Brazil suffered a speculative attack
and a sharp devaluation, protectionist responses emerged in the other members of the
regional trade agreement. The small countries, Paraguay and Uruguay, had regularly
confronted sectoral protectionist barriers from the bigger partners, aggravated by there
weak power of negotiation. And more recently, even in the face of generalized devalued
currencies, the end of the fix exchange rate regime (convertibility) in Argentina, common
flexible exchange regimes in the region, we observe systematic protectionist practice.
We also should note that the relative importance of the protectionist activity of a
given country, tends to depend on the size of the devaluing economy. We should not
expect the same reaction in Nafta when Mexico devalues, with 4% of regional GDP, than
in Mercosur if Brazil devalues, with 65% of regional GDP. This general argument should
in turn be qualified considering sectoral impact i.e. a small country with a strong
competitive advantage in a given sector that affects sensible (or active) players (regions)
in a bigger country. In Mercosur, the source of regional RER volatility has originated
primarily in the major partners, thus increasing the incentives for protectionist behavior.
Indeed, the interest to develop buffer measures for these episodes of sharp RER
discontinuities should be considered. Transitory predetermined (in time) compensatory
measures, in particular, for the transitory overshooting of the RER of the devaluing
economy should be discussed. The aim would be to contain persistent protectionist
barriers triggered by transitory price changes, thus increasing the robustness of the
integration process.
V. What should be coordinated in Mercosur?
Macroeconomic coordination has not been high in the agenda of Mercosur, and less so
for the major countries of the regional agreement, Argentina and Brazil. Despite the
natural slow learning by doing process in any cooperative venture, the national urgencies
in an unstable region have strongly contributed to delay and distort the regional policy
initiatives. Lavagna y Giambiagi (2000) argue that two fundamental sources for the
paralysis in the regional coordination game could be identified. The first would be the
36
strong disparities in macroeconomic trends of the major partners of Mercosur. In fact
after extreme monetary disorder in the 1980s, Argentina achieved price stability in 1991
(the convertibility law), while Brazil suffered high inflation until the end of 1994 when
the Real Plan was launched. These authors also highlight the difference in
macroeconomic objectives in these countries, where the exchange rate was the instrument
to anchor price stability in Argentina while the main target in Brazilian policy would
have been the current account balance. The second source of delay in the coordination
process would rely on the priority assigned in the early stages of integration to the
objective of dismantling regional trade repression i.e. extreme commercial distortions,
leaving for future initiatives macroeconomic coordination.
The speculative attacks suffered by the Brazilian currency, followed by a sharp
devaluation, in January 1999 provoked intense pressures on the Mercosur trade
agreement. Argentina, anchored to the dollar under the convertibility regime was facing
an economic contraction since mid 1998, now aggravated by the abrupt change in the
bilateral RER with its major trade partner. As could be expected, the Brazilian currency
initially showed an overshooting triggering demands for protectionist responses in
Argentina. Stronger incentives to develop cooperative policies were thus in place. The
political consensus in Argentina was still strongly behind the Convertibility rule, thus
requiring a regional strategy based on the coexistence of a fix exchange rate regime (and
appreciated currency) in the latter and a newly adopted flexible exchange rate regime
(and over-depreciated currency) in Brazil. More recently, all the countries of the region
had converged on common flexible exchange rate regimes based rethorically on inflation
targeting rules. But one could argue that the problem of disparities in objective is again
present today. The monetary policy gives priority to inflation in Brazil, while beyond
rethoric, Argentina seems to reveal a strong preference for some variety of exchange
targeting. Policies seem to show again diverse – if opposite from the 1990s - preferences.
In the year 2000, the governments of Argentina (newly elected)30and Brazil
decided to launch a set of cooperative initiatives, in particular in the macroeconomic
arena. The Mercosur countries agreed to a) develop common macroeconomic objectives,
b) construct comparable and consistent macroeconomic indicators for the country
members – the existing indicators for relevant variables were based on diverse
methodologies – c) publish regularly the fiscal indicators of the Mercosur countries
enhancing transparency and common knowledge of national public finance status, d)
establish cooperatively a set of common targets for budget deficits, public debt and
inflation, e) and develop studies on the working of national capital markets in view of the
future integration (a regional market), and finally f) the creation of a flexible institution in
charge of macroeconomic initiatives, the Group of Macroeconomic Monitoring
(GMM).31
In line with these objectives there was significative progress in the harmonization
of statistics on budget deficits, public debt and prices in the region, a necessary step to
discuss common macroeconomic rules. The countries of Mercosur had also agreed a set
of macroeconomic targets a la Maastrich, such as a maximum inflation rate of 5 per cent
30
The strategic international focus of the new government was biais towards Mercosur, as opposed to the
more ambiguous policy of the previous administration of President Menem.
31
See Machinea (2004).
37
until 2005, and of 4 per cent from that year onwards; a budget deficit (consolidated) of 3
per cent of GDP, and a decreasing trend for public debt, reaching a level of 40 per cent to
GDP in 2010. An European approach to manage country deviations from the targets was
proposed: the administration of the country in question was expected to present a
convergence plan to the GMM, and show concrete actions in view of the application of
the proposed corrective plan within a year. If the enforcement of convergent policies in
the face of important deviations from the collectively agreed targets are a serious problem
in Europe, this was more so in Mercosur in the beggining of the coordination practice.
Furthermore, the macroeconomic collapse of Argentina in late 2001 and 2002, with the
regional financial epidemics and contagion led to great disturbances jeopardizing the
continuity of the coordination initiatives. The current regional challenge is thus to
relaunch and reconsider an agenda of negotiations on macroeconomic issues.
V.A. Macroeconomics of Mercosur: A favorable stand
The analysis of the macroeconomic indicators and the current (and past) performance of
the Mercosur countries is an important step in the search of a potential Germany (leader)
in the region. Furthermore, it would help identify the disparities in policy preferences of
the different countries, i.e. varieties of revealed preferences. Even in the face of
symmetric shocks for the economies of a region, a weak difference in the country
preferences (or convergence) would be a critical issue. Indeed, a great disparity in policy
preferences may lead to different policy responses to a common shock from the countries
of the region. In conducting such an analysis it is important to consider not only actual
differences but also potential differences in preferences.
After decades of monetary disorder in the region, with the extreme experiences of
hyperinflation in Argentina, the 1990s highlight a remarkable success in the inflation
front (Graph 14). Furthermore, inflation rates in Mercosur have shown strong
convergence: way through the sharp devaluations in the late 90s and the first years of this
decade, the natural acceleration of inflation proved to be transitory.32 Today, inflations
rates in the region are below 10 per cent. How permanent is this path for inflation? If
opinion polls show that the regional population primary concern these days is
unemployment and social exclusion, low inflation remains an important issue ( Graph
16). Would the viewers of past films grow older and new majorities emerge lead in the
future to a return to inflation populism? This question may not be sheer science fiction
when discussing the costs and benefits of macroeconomic coordination or a monetary
union in the Mercosur.
In what concerns fundamentals, we observe that massive budget deficits in the
1980s, and then gradually out of control in the second half of the 1990s leading again to
speculative attacks and financial crisis in the countries of the region, have shown an
impressive turnaround (Graph 15). We observe budget surplus in Argentina and Brazil,
and balanced results in Paraguay and Uruguay, with results recently better than the
Maastrich rule of 3 per cent. We should however highlight that in view of the historical
records of public finance disorder, monetary turmoil and low financial intermediation, the
32
To the surprise of many respected analysts that based on the historical record and the expected
reemergence of indexation mechanisms had anticipated price explosions and a return to past sins.
38
countries of the region should aim at more conservative stands than Europe to gain
credibility. Growing budget deficits in the mid 1990s coupled with easy access to
international capital markets showed in rising levels of public debt (Graph 17) : with high
shares of dollarized or dollar-indexed public bonds, devaluations produce strong
disequilibria in the state balance sheet. This was particularly so in the cases of Argentina
and Uruguay in 2002, were public debt to GDP ratios exploded, reaching level higher
than 100 per cent. Debt default and massive contractual disruptions (pesification)
followed in the former, while voluntary debt restructuring was managed in the latter.
If these two economies have shown strong economic rebounds and public finance
stands are more robust than in the past, the long term trends remain uncertain. The
international environment is certainly a question mark: will the current favorable
commodity markets and low interest rates persist? In any case, after years of severe
turmoil, we observe a quasi-magic phenomena of convergence, in economic indicators as
well as in exchange rate regimes with generalized floating in the region. Inflation
targeting is in fashion, even if some countries go more than others by the rules of the
game. The countries of Mercosur also share common challenges: persistent
unemployment and social exclusion, sustained growth trends, high levels of public debt
and balance of payments vulnerability. But again, are these transitory or permanent
features of the economics and policy preferences of the region?
The role of regional monetary leader is not in excess supply. The largest country
in the region, Brazil, displayed an average inflation rate of 394.5% between 1991 and
2003, strongly influenced by the extreme inflation episodes of the 1990s (1991-1994),
when the inflation rate reached four digits. The countries with the lowest rates for the
same period are Argentina and Paraguay (12% on average). The former showing a decade
of price stability, but extreme monetary mismanagement in previous decades and again
facing severe macroeconomic crisis in 2001-2002. Uruguay showed an intermediate level
of inflation, with 28.4% in the period. Despite the recent convergence in macroeconomic
indicators, markets do not forget that excessive budget deficits, monetary disorder, high
inflation, balance of payments crisis and speculative attacks have been chronic events in
the last decades. None of the countries of the region has a long (and even short) history of
stable and credible monetary behavior, as it was the case with Germany in Europe. True,
memory can be partly erased as the German experience itself has shown, this country
having in its monetary history the experience of hyperinflation in the 1920s under the
Weimar Republic. Economic, political and social disorder and World War Two were
fundamental events in the German markets until the late forties. The monetary credibility
of Germany today has been hardly won.
The analysis of the disparities in preferences, of voters and policy makers, seems
to point out that the country showing the strongest bias towards price stability may have
been Argentina in the 1990s. This country had sacrificed the nominal exchange rate as
adjustment mechanism, and consequently was forced to experience large and protracted
output and employment contractions in response to adverse external shocks. The other
countries of the region, even under stabilization programs, have conveyed more
flexibility to the exchange rate policy. Nevertheless, the credibility ranking of Argentina
has been seriously jeopardized after the public debt default of 2001. A longer term
perspective of 25 years, would yield Paraguay as the relative best monetary performer.
39
But size, institutional weakness and current political instability prevents the country as a
potential anchor player for the region.
The risk of severe macroeconomic divergence in the region seems to have
diminished in the 1990s, where the countries of the region have showed a high degree of
macroeconomic convergence. However, based on the past historical economic behavior
such a risk of renewed divergence in the future cannot be discarded. On the positive side,
as of today the countries of Mercosur have in common flexible exchange rate regimes
(different versions of floating systems). These recent trends could indicate a growing
convergence in preferences in the region, thus diminishing the costs of coordination (in
terms of the utility of the policymaker). On the negative side of flexibility, the implicit
discretion in monetary policy is higher and may lead to destabilizing monetary policies
and potential negative contagion effects between these economies. The fact that the
economies of Mercosur may have a bias towards divergence in the future may also be an
incentive to implement coordination mechanisms to prevent the panics of the past. In
such a case, coordination could act as a peer-control that allows countries to put in place
policies and reforms that they wouldn’t be able to apply just by themselves.33
Graph 14
Convergence in Inflation (CPI)
140.0%
Uruguay
120.0%
Paraguay
100.0%
Argentina
%
80.0%
Brazil
60.0%
40.0%
20.0%
Year
33
See Carrera, Sturzenegger and Levy Yeyati, 2000.
40
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
-20.0%
1990
0.0%
Graph 15
A deteriorated fiscal balance (% of GDP)
4.0%
2.0%
%
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
-2.0%
1990
0.0%
-4.0%
Uruguay
-6.0%
Paraguay
-8.0%
Argentina
-10.0%
Brazil
-12.0%
Year
20.0%
18.0%
16.0%
14.0%
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
Uruguay
Paraguay
Argentina
Year
41
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
Brazil
1990
%
Graph 16
Unemployment in Mercosur countries
100.0%
90.0%
80.0%
70.0%
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
Uruguay
Paraguay
Argentina
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
Brazil
1990
%
Graph 17
Public external debt in Mercosur countries (% of GDP)34
Year
V.B. The exchange rate policy
We have already mentioned that the exchange rate policy was a central element since the
beginning of the European Community. We also observed that fluctuations in bilateral
RER may have a negative impact on regional trade jeopardizing the progress in the
process of integration. In the case of Mercosur we should analyze the role that exchange
policies should play to reduce regional RER volatility.
Monetary union in Mercosur has been frequently discussed. A common currency would
eliminate exchange rate volatility in the region contributing to the development of trade
integration. But the existing consensus on the issue highlights the absence of the
conditions set by the OCA theory for a beneficial currency union.35
The favorable view on monetary integration would consider the endogeneity of
the OCA criteria i.e. a dynamic approach as opposed to the static approach. Indeed, the
countries would engage in a process of a monetary union expecting that future expost
benefits will be higher than costs. However, the country members of the currency union
may be subject to asymetric shocks after monetary integration.36 The issue of managing
this disparity in shocks and response may remain.
Exchange rate coordination agreements in Mercosur based on exchange rate
bands have been less explored. Currencies may fluctuate within predetermined bands, as
34
For Uruguay is total public debt.
Licandro Ferrando (2000a), Stein and Panizza (2002) and Machinea (2004).
36
The problem of dealing with asymetric shocks, under a currency union, should be discussed. Again,
redistributive fiscal tranfers in the region could be an answer, despite the political economy difficulties
previously mentioned i.e. the resistence of relative poor fractions of the population (or regions) of a country
to accept tranfers to relatively richer countries (populations).
35
42
experienced in Europe with the snake and the EMS. A regime of exchange bands allies
the need of flexiblity to respond to asymetric shocks, with the benefit of limited volatility
aimed at fostering the process of trade integration. In the trade off flexibility-volatility a
system of bands is an intermediate solution for coordination: in between an irrevocable
currency union and autonomous non coordinated monetary policies. In 1993 a system of
bands was proposed by the Brazilian authorities centered on bilateral RER parities. The
expectation was then to implement such a regional exchange rate regime in 1995,
simultaneously with the launching of the common external tariff for extra-regional
imports. Two types of bands were proposed, a reduced one for the major economies
(Argentina and Brazil) and a larger band for the smaller economies. The declared
objective of the regime of bands was to contain competitive devaluations. An
intervention fund was designed (Regional Intervention Fund), inspired in the European
experience, to contain excessive exchange fluctuations.37 In view of the limited
ressources of the Fund, the latter was expected to concentrate the interventions on the
smaller economies. To reduce the incentives of competitive devaluations, it was also
proposed to set a system of penalties based on extraordinary regional import tariffs for
the countries devaluing its currency.
But some issues should be highlighted. It is from the major economies of the
Mercosur that more often come the financial disorder and bursts of extreme volatility,
thus a system of stabilization funds focused on the smaller countries would leave the
initial problem open. The credibility of the regime of bands would be weakened. On the
same brand, if the fundamentals (fiscal, debt, terms of trade, etc) are misaligned a
devaluation may be a necessary adjustment or the result of a speculative attack in the face
of a credibility crisis, not necessarily a voluntary competitive devaluation. Such was the
case of Brazil in January 1999. The role of disequilibrium in fundamentals, exchange rate
volatility and the means to obtain stability should be carefully discussed. But in the mid
1990s the proposal of implementing a system of bands was not in the common agenda:
Argentina was under the currency board and convertibility, while Brazil with a flexible
exchange rate regime and dealing with high inflation. The disparities in monetary
regimes and macroeconomic stands prevented progress towards a regime of regional
exchange bands.
The current convergence in economic trends and exchange rate regimes contribute
to a positive dialogue on a common agenda for macroeconmic coordination. A system of
bands could be an instrument for regional discussion if the natural caveats born from the
existing experience are not neglected. One could then consider establishing adjustable
central parities with a lower and upper bound of the band allowing for an interval of
exchange fluctuation. The regular revision of the central parities avoids the growing
pressures on the system that may arise from persistent disequilibria, eventually leading to
speculative atttacks. In view of the European experience, the adjustment of parities
should require a collective agreement, and complementary policy measures (budgetary,
etc) to reinforce sustainability. Excesive flexibility may feed vicious circles, eventually
contributing to increase volatility instead of diminishing it, the very first objective of the
coordination.
37
See Lavagna and Giambiagi (2000).
43
In general terms the width of the band is the instrument to diminish speculative
attacks, avoiding sharp jumps in the nominal exchange rate. In the limit, this argument
explains that free floating regimes are less prone to speculative attacks than rather rigid
exchange rate arrangements.38 One should expect that the bands in Mercosur should be
wider than in the European experience, considering the higher degree of shock asymetry
and the potential frequency of attacks on the currencies in the former region.
However, the functioning of exchange rate bands in Mercosur may face many
problems. In the first place there is the scale and volatility of capital movements. It has
been argued that unstable capital flows are a serious source of instability and may
jeopardize the well functioning of a regime of restricted exchange bands.39 The level of
currency reserves in these countries is relatively low compared to the size of capital
flows, thus weakening the defensive line of Central Banks in the face of sharp
turnarounds in private portfolios. In the face of speculative pressure on the currency
relative low levels of reserves in international currencies may force a sharp devaluation.
This argument stands true in the case of the parity of a weak currency in terms of the
(strong) international currencies, but less so in the case of the bilateral parity of two weak
currencies such as the peso and the real. In theory, if the Central Banks of Argentina and
Brazil freely float against the dollar, nothing prevents the fixing of the peso-real parity.
For a number of fundamental reasons stability of the latter currencies in terms of the
dollar cannot be neglected, thus the relevance of the volatility argument linked to
unstable capital flows returns to the scene.
TO BE WRITTEN
Given the long history of monetary disorder and balance of payments crisis in the
region, exchange rate coordination may show a severe lack of credibility, even more so
than the European Union has suffered in the past. Furthermore, the system of bands are
easier to reverse – less irrevocable – than a monetary union. Indeed, the member
countries of a band arrangement may opt out at a lesser cost. In such a case, speculative
attacks would be the rule rather than the exception.40 Another feature that may weaken
credibility in Mercosur is the absence of a leader that anchors the band system.
Furthermore, a high probability of occurrence of asymmetric shocks, as is
apparently the case in Mercosur countries, may require frequent adjustments of the
nominal exchange rates in the future and, what is worst, may lead the countries to leave
the system after all (as was the case with many countries in the European case). The
credibility cost would be high. In a world of rational expectations, these events will tend
to be anticipated and credibility handicap may lead to a selfulfilling prophecy dynamics.
The band regime could be seriously hur from day one.
But whatever the form exchange rate coordination takes (exchange rate band or
monetary union), a fundamental issue to account for concerns the role of extra-regional
currencies. Dollarisation is an important feature of the economics of Mercosur, through
38
See de Grauwe (1994).
39
See Eichengreen (1998) and Machinea (2004).
Tal como ha sido señalado con anterioridad, en el caso europeo Italia, debido a la poca credibilidad que
disfrutaban sus instituciones monetarias contaba con una banda de fluctuación superior a la del resto de
los paises.
40
44
its role in the private portfolios and the public debt in foreign currency (or bonds indexed
to the dollar), as well as through the price of commodity exports.41 Sharp changes in the
parity of the domestic currency with the dollar will thus have an important impact on the
“balance sheet” of the public sector and on companies and may cause financial fragility.
The situation is more complicated the greater is the dollar obligation of the banks
(dollarized deposits). In such a case, attempts to reschedule obligations may entail a loss
of credibility and may also trigger a bunk run if people think they are going to take place
in the future, causing magnificent macroeconomic damage. In such situation, and as the
Argentinean experience shows, contractionary effects may well be greater than
expansionary ones. This was not the case in the European environment. Under conditions
of high degree of dollarisation any strategy of exchange rate coordination should
restrain the variability of the parity with the dollar.42
Another issue worth considering is the fact that Brazil has often resorted to the
exchange rate as an instrument for external balance(output) targetting, while Argentina
monetary policy (regime) has focused on price stability. Today, relative preferentes sem.
to revert and Brazil shows a high level of commitment on inflation targetting, while
Argentina follows a rather ambiguous objective, with a bias on exchange nominal
stability. If the disparito in preferences concerning monetary instruments and objectives
prevails some countries will be less prone to peg its currencies (Brazil in the past,
Argentina today). Cuando las diferencias en tamaño entre los países son muy
acentuadas, los incentivos de los economias de mayor tamanio a coordinar pueden verse
reducidas de manera significativa.43 Ello se debe a que el “socio mayor” deberá
resignar instrumentos soberanos de su política económica para obtener en contrapartida
pequeños beneficios de la parte de los socios.
La conclusión de la seccion pareceria ser que si bien existen argumentos muy
justificados para fijar los tipos de cambio bilaterales (dada la alta volatilidad del tipo de
cambio real y su impacto negativo sobre el comercio), no es menos cierto que pueden
existir dificultades importantes en un eventual intento de fijación mutua. In particular,
the region may need a regime of flexible exchange rate coordination with bands too wide
to accommodate disturbances. En un caso como este podrian existir fuertes fluctuaciones
en las paridades bilaterales, con lo que la razon de ser de un sistema de bandas (limitar
las fluctuaciones) incluso perderia sentido. Ademas, debe mantenerse presente que
cualquiera sea la forma fijación elegida, siempre debera mantenerse algun grado de
fijación frente a terceras monedas, dada la dolarización parcial en la que estan inmersas
las economias de la region. Luego, si la region desea avanzar en la coordinación de
41
The original sin problem prevents the agents of peripheral countries of issuing international debt in
domestic currency.
42
Merece la pena destacar que el hecho de que varios paises se encuentren parcialmente dolarizados o
dependan en forma importante de la evolucion de la divisa norte americana reduce de manera significativa
la necesidad de contar con un lider en el proceso de coordinación monetaria. Ello es asi dado que al verse
en la necesidad de atarse, aunque sea parcialmente, a terceras monedas (Por ejemplo, los paises pueden
crear una moneda unica y esta estar atada parcial o totalmente a la evolucion de una moneda fuerta como el
dolar o el euro. Tambien seria el caso si los paises pequenios fijan sus paridades al real y a su vez este se
fija total o parcialmente a una tercera moneda.), los paises “importan” en parte la credibilidad del pais
emisor de la moneda fuerte.
43
See Licandro Ferrando (1998).
45
politicas macroeconomicas deberia ser para lograr otros objetivos que los de la
reduccion de la volatilidad del tipo de cambio real. Este es el objetivo de la seccion
siguiente.
V.C. Preventing financial instability and contagion
TO BE WRITTEN
Con anterioridad se ha mencionado que los dos socios mayores del Mercosur
constituyeron una fuente de volatilidad financiera en la región con lo cual estas naciones
deberian estar propensas a discutir eventuales mecanismos para evitar que tales crisis
vuelvan a producirse y que se transmitan a los socios comerciales. Con relacion a tales
medidas, lo primero que vale la pena mencionar es que un elemento que seguramente
contribuira positivamente a evitar la existencia de tales crisis en el futuro inmediato
viene dado por el hecho que los paises del Mercosur estan aplicando politicas
cambiarias que consisten en una cuasi flotacion de sus monedas. Los riesgos de ataques
especulativos se ven entonces reducidos a partir de esta nueva coyuntura regional. The
coordination of macroeconomic policies could be focused on three fronts in order to
preserve the stability of countries and as such, to avoid financial crisis: fiscal deficits,
the level of public debt and inflation.
Numerosos estudios tienden a mostrar que el nivel de deficit fiscal y de deuda
publica repercuten en aumentos en la tasas de interes locales44. A su vez, tambien es
sabido que los rendimientos de los activos de las economias emergentes en general se
encuentran estrechamente relacionados. Siendo este el caso, pareceria logica la
imposición de restricciones mutuas sobre las variables fiscales con el objetivo directo de
impedir el contagio entre los paises del Mercosur. The European experience is very
important in this respect.45 On the one hand we should note that Mercosur countries had
historically by far greater fiscal deficits than their European counterparts. Also, a key
difference with the European case is that Mercosur countries had fiscal deficits even
when the economies were enjoying relatively high rates of economic growth (as in the
90s). And even if in the current situation Mercosur members enjoy a relatively
comfortable fiscal situation, we can not exclude the possibility that a new foreign capital
entry or that the inflationary tax would be used again to finance such deficits. So, bearing
in mind the region’s vulnerability, fiscal deficit and debt levels may have to be lower than
those set in Europe (“low debt” constraint).
On the other hand, there seems to be an agreement on the fact that rigidly
imposed fiscal targets impede the application of countercyclical policies. As such, the
idea of working with the “structural deficit” (a fiscal deficit adjusted by the economic
cycle) emerged naturally.46 The idea here is that the fiscal deficit ceiling should be higher
in recessions than in expansions. The main problem is that the definition of cycles is an
ex post exercise by nature while the application of “structural deficit” target would be
44
Gavin and Hausman (1999) and Grandes (2001).
Remember that in the Maastricht Treaty it is hold that countries can not have fiscal deficits of more than
3% of GDP and that government debt can not exceed 60% of GDP.
46
Heymann (2001) and Machinea and Monteagudo (2002).
45
46
an ex ante problem. This is, in order to define the level of the target we need to know “in
advance” the evolution of the economic activity. Of course, some instruments have been
developed to forecast economic activity such as the literature on leading economic
indicators but errors can not be excluded at all. So, while this idea is very appealing in
theory, there are many troubles in its practical application.
En lo que hace a la coordinación de limites a los niveles de endeudamiento
publico, un argumento por el cual los paises de la region deberian coordinar la
imposición de tales limites de deuda a PIB bajas debido a potenciales problemas de
liquidez. En particular, los paises deben refinanciar continuamente una parte de su
stock de deuda que llega a vencimiento, siendo muchas veces elevados los montos
involucrados como para ser financiados unicamente a traves de superavits fiscales. Dado
que la generacion de semejantes superavits es politica, economica y socialmente muy
costosa, los paises recurren para fondearse a los mercados de capitales privados. Sin
embargo, y como es ampliamente conocido, los mercados a los cuales nuestros paises
tienen acceso exhibieron una volatilidad importante, secandose en periodos donde mas
se los necesita. En casos como este, los gobiernos se ven en la necesidad de aplicar
politicas fiscales contraciclicas justo cuando seria necesario hacer lo contrario,
exacerbando la volatilidad de la actividad real. De manera natural, entonces, surge la
necesidad de contar con niveles de deuda tales que su refinanciación sea lo menos
traumatica posible.
No menos importante es la necesidad de inspirar confianza en el plano fiscal, esto
es, hacer ver a los prestamistas que la solvencia fiscal podra mantenerse en el futuro y
de esta manera no se pondra en peligro el cumplimiento de las obligaciones contraídas.
La aplicacion de “fiscal rules”,47para reformar los procesos de creación de los
prosupuestos de forma tal de generar transparencia presupuestaria e incluso crear
comites de control fiscal independientes. Un elemento adicional que deberia
considerarse es que la consecución de un acuerdo regional en materia fiscal, de ser
creible y duradero, puede enviar la senial necesaria para generar “confianza
intertemporal” por parte de los paises del Mercosur.
Dado el pasado inflacionario de la region, con Argentina alcanzando una
hiperinflación en 1989 y con Brasil mostrando una inflación muy elevada hasta la
aplicacion del plan Real en 1994, parece necesario explorar el rol de los acuerdos
regionales en materia de control de la inflación. El problema no pasa solo por los niveles
de inflación alcanzados sino tambien por aplicación fallida de un sin numero de planes
de estabilizacion que erosionaron la credibilidad de las autoridades monetarias
regionales.48 La voluntad estabilizadora deberia entonces ser evidente y constituir un
objetivo regional clasificado entre las necesidades mas prioritarias. La coordinación de
politicas monetarias entre los paises del Mercosur podria actuar como una senial al
sector privado del tipo de gobierno que tienen en frente. Solo el gobierno comprometido
con la lucha antinflacionaria se mostrara proclive a la coordinación intraregional. De
lograrse tal coordinación, los agentes del sector privado sabrán que se trata de
gobiernos que ponderan en forma importante la inflación y que intentaran luchar contra
47
Al estilo de la “ley de convertibilidad fiscal” que la Argentina pretendio aplicar en el 2000-2001.
Asi, entre 1967 y 1990, Uruguay fracaso en dos intentos por controlar la inflacion, Argentina en cuatro y
Brasil en cinco.
48
47
ella. Este hecho actuaria ex ante reduciendo las expectativas inflacionarias y
posibilitaria ex post la consecución de una menor inflación.
De manera directa, la instauración de una moneda única puede restringir la
posibilidad de aplicar politicas monetarias inconsistentes que revivan el pasado
inflacionario de la region. In the bad scenario it could trail evrybody to hell. In such a
case, credible constraints on the capacity to issue money on the part of member countries
may prevent the use of monetary policy to exploit the short run trade off between inflation
and unemployment, which sooner or latter will finish bringing forth inflationary
expectations.49 Como ya se ha senialado, la posibilidad de crear una moneda unica en el
seno del Mercosur parece remota en la actualidad. De esta manera se abre la necesidad
de buscar otras vias mas flexibles de coordinación en materia monetaria.
Two final comments should be made concerning the financial system and the
current account. As shown by the Asian crisis, the financial system may be either a
channel through which shocks in other parts of the economy are translated or may be a
direct cause of incertitude and volatility. In both cases, it is very advisable to count with
measures that strengthen the financial system of our countries by progressing on the
coordination of prudential regulations and supervisory practices. Also, the recent
experience of Argentina seems to show that high current account deficits may become
unsustainable and may so be a source of instability in the region. The situation may be
even worst when that deficit is financed by short term external debt, as was the case for
many of the countries that experienced financial crisis. The application of limits on short
term debt and measure showing concern on the state of the current account deficit may
lessen the vulnerability of these economies.50
Antes de finalizar la sección es importante resaltar que algunas de estas medidas
podrían no ser llevadas adelante si quisieran realizarse a nivel nacional. Este seria el
caso, por ejemplo, de medidas de control del déficit fiscal, que son muy contestadas en
general a nivel nacional. De esta manera, los acuerdos regionales pueden ser muy utiles
para implementar medidas que generan resistencia en el plano interno y que serian
fácilmente reversibles.
V.D. Coordination rules and enforcement design
In this sub section we address the problem of enforceability of the rules embedded in the
coordination effort in Mercosur. From the European experience we know that the
Maastricht Treaty empowered the European Council to impose sanctions to those non
complier countries, in the form of a non – interest bearing deposit which was converted
into a fine after two years, unless the excessive deficit has been corrected. The problem
49
Un Banco Central independiente y con un fuerte compromiso antiinflacionario podria incluso repercutir
en un menor costo de endeudamiento en los mercados internacionales.
50
Por supuesto, es de esperar tambien que en la medida que la coordinación de las politicas mencionadas
en los parrafos anteriores sea exitosa, se produzca una reduccion en la volatilidad de los tipos de cambio
reales bilaterales (y esto, en forma independiente al esquema cambiario elegido por cada pais). Esta
conclusión se obtiene de la observación según la cual en la decada del 90 se produjo una sustancial
reduccion de la volatilidad de los tipos de cambio reales bilaterales entre los paises del Mercosur de la
mano de la mayor estabilidad macroeconomica de los paises de la region (Machinea, 2004).
48
then arises of how to design incentives to keep countries committed even in different
circumstances. In the case of Mercosur the problem is very important because countries
do not have credible institutions and because the region faces important shocks that may
produce important deviations of the targets.
It then seems that the incentives in the Mercosur case will have to be strong
enough to keep countries committed even in different situations. In Europe the incentives
were based on: losing face if they did not participate in the process (as was the case in
France in 1983);51 strong trade interrelationships, which threw a very negative light on
any given partner’s instability (especially with exchange rates); and economic and
political sanctions for not meeting targets.
In the Mercosur case these elements are present in a by far lower degree. When
the gains from coordination are visible and shared between countries, coordination
mechanisms could be relatively easily implemented. In such a case, only the menace to be
excluded of the process is sufficient for the countries to keep their policies in line.
However, if benefits are not clear or are unequally distributed there is a great chance
that some of the countries may finally leave the process. En el caso del Mercosur la
forma en que se reparten los beneficios de la integracion no esta bien definida (por
ejemplo, los paises pequenios que son los que mas se benefician con el comercio intra
regional son también los que mas se perjudican con la volatilidad financiera de los
socios mayores). Esto lleva a que no exista un “costo de reputacion” por no cumplir con
los acuerdos regionales.
Also and as was already shown, even if intra regional trade has grown
importantly since the beginning of the 90s, the level of interdependence seems still to be
low. Sin embargo, un elemento adicional no presente en el caso europeo y que debe ser
tenido en cuenta es que los movimientos internacionales de capitales pueden constituirse
en un mecanismo de castigo comun a todos los paises del Mercosur (si uno de los paises
no cumple con lo establecido en el acuerdo regional, todos los paises pueden verse
penalizados via una salida de capitales). Tal como ha venido ocurriendo en el pasado, si
los movimientos de capitales penalizan de la misma manera al pais que aplica politicas
inconsistentes y al que no cumple con los pactos regionales, entonces podrian generarse
incentivos adicionales a la búsqueda de mecanismos de enforcement por parte de los
socios.
Finally, one possibility to increase the “enforcement” is the creation of groups of
regional and non – regional experts to assess the compliance with the agreements and to
make public assessments and recommendations. Such a group would act as a “peer
pressure” that should increase the compliance of accords.52 The menace of exclusion of
the process it is not en option for the case of Mercosur given the few number of member
51
By 1983, a significant part of the French government considered the EMS as a too constraining tool. As
such, proposals emerged to leave the system at all. At the end, this was considered a too risk option in
terms of inflation, since by the time the international reserves were not judged to be sizable enough to
defend the franc. A way out of the system would have implied a huge depreciation of the franc and a
raising inflation. It was then preferable to engage in a domestic stabilization effort in accordance with
Germany, in return of an assurance that the franc would be defended strongly using resources of the EMS
central banks.
52
Machinea (2004).
49
countries. As such, it would be impossible to consider a Mercosur without Argentina or
Brazil in case these countries do not comply their obligations.
Even like this, it seems that the general agreement on this issue point to the
conclusion that it will be very difficult for Mercosur countries to keep their promises and
to comply with agreements made. La diferencia con el caso europeo es en este caso
particular bien marcada.
VI. Conclusion: Reversing European Monetary Integration
In view of the theoretical and empirical analysis developed we conclude that as of today
Mercosur does not satisfy the standard conditions dor an optimal currency area. The
question that naturally emerges is the following: why should the countries of this region
embark in a process leading to monetary integration or a weaker venture of
macroeconomic coordination of the various versions considered? A first answer relies on
the evidence of extreme real exchange rate volatility in the region leading to a loss in
regional trade, thus jeopardizing integration and diminishing collective welfare.
An alternative to confront this problem would be the adoption of a system of
currency bands. A regime of bands may be an intermediate solution for the trade off
between the need for flexibility to absorb asymetric shocks, on one hand, and the
objective of diminished exchange rate volatility to foster intra-regional trade, on the
other hand. On the downside of this regime lies the low credibility thta prevails and tus
the high risk of frequent and deep speculative attacks.
On the favorable side for a successful coordination of monetary and fiscal
policies we should note the gradual convergence of macroeconomic indicators in the
region. However, based on the past historical economic behavior the risk of renewed
divergence in the future cannot be discarded. De esta manera, estos países pueden ser
“potencialmente” diferentes en el futuro, lo cual queda evidenciado en los diferentes
comportamientos macro de la década del 80 y en las crisis financieras que sufrieron los
países del Mercosur. Además, esto se da en un contexto en el cual la interdependencia ha
aumentado a través del tiempo, con lo que un comportamiento disfuncional en uno de los
miembros (especialmente los mayores) se traslada fácilmente hacia el resto. Thus the
need to coordinate macro policies aimed at sustainable, budget deficits, levels of public
debt, current account balance, etc. Fundamentals first.
Based on the above arguments we conclude that the preferred strategy for
Mercosur should be the reversion of the sequence of coordination developed in Europe.
We thus propose to start ith a first phase where the region would focus on the
coordination of fundamentals – budget deficits, debt and inflation targets (monetary
rules?) to build reputation and buy credibility, certainly in demand. In a second phase,
the coordination game could engage on exchange rate coordination, considering its
various alternatives. A system of currency bands could then be an interesting option. In
any case we should highlight that if the appropriate response to the political economy
issues mentioned in this paper do not constitute a sufficient condition for successful
integration, it may be a necessary condition. Regular regional growth may be at the
50
source of various destabilizing reactions from groups and regions that may jeopardize
integration (Heymann, 2005).
51
52
Table 3
Mercosur and Europe in perspective
Europe
M
Benefits
•
•
RER volatility (+)
Trade levels (+)
•
Costs
Symmetry of shocks (-)
Low trade an
(even when con
High trade and low RER volatility.
•
•
•
Shocks are more asymmetric in Mercosur. Cycles are also less sy
Endogeneity of OCA criteria (shock asymmetry) seems to be less
Shocks are bigger in Mercosur.
Low flexibility in prices and wages.
OCA
Substitutes for
monetary/exchange rate
policies
•
•
•
Flexibility of prices and
wages.
Labour mobility.
Fiscal redistribution.
Contagion
Interdependence and Coordination
Credibility
Political economy
Low labour mobility.
Higher flexibility
•
•
•
•
•
Existence of federal budget (redistribution)
- Imbalanced, PAC dominance.
High disparities in
Language transact
Rich countries are
Political resistanc
labour mobility.
The buffer of econ
Inexistence of federal
• Brazil rescue may
• High intra country
• Political resistanc
resist redistributio
•
High commercial interdependence.
•
•
Lower commercia
High financial interdependence
(crisis and contagion in the 90s)
•
High financial int
•
Monetary leader (Germany).
•
No leader on the m
•
Sizeable reputation gains for many
countries (Italy, Spain, Greece, etc.).
•
The distribution o
•
Important potentia
countries.
High political will. The system tends to
overcome crisis. The resistance against
lobbies is high.
53
Lower political w
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