European Monetary Union and Capital Markets: Volume 2

As an introductory chapter, this paper provides a summary of various issues pertaining to economic adjustments after the launching of the euro as a single European currency. Monetary union is viewed as a process of integration of capital markets and real sectors.

This paper outlines the organization structure of the European System of Central Banks, comprised of the European Central Bank and the central banks of European Monetary Union member countries. Also outlined are the policy procedures used by the European Central Bank as it implements a common monetary policy for all member countries.

Mean breaks in the Franco-German interest rate differential prior to European Monetary Union can have an economic interpretation, namely gains or losses in credibility of the corresponding ERM central exchange rate. A variety of tests are used to detect such breaks, on daily data covering the 1990s. The analysis paints a broadly consistent picture of these breaks and how expectations evolved before EMU. Results suggest that credibility was characterised by gains as well as setbacks; however an effective convergence is found from 1996 onwards, suggesting a major increase of the credibility of the French participation to EMU around that date.

This paper distinguishes exchange rate variability from exchange rate misalignments and presents statistical measures in this regard. It uses PPP as a crude approximation of equilibrium exchange rates and shows that during periods of possible misalignments, the exchange rate variability of some EMS and other currencies tends to increase.

The introduction of the euro followed a period of restructuring in corporate Europe and contributed towards the integration of financial markets and transparency in equity pricing. In this process the euro facilitated the development of alliances among exchanges and infrastructure providers. As argued in this paper, while the ability of issuers to place larger issues was enhanced after the advent of the new currency, the euro was not the main reason behind the extraordinary IPO activity observed in the period after 1998. Other factors, such as the need of corporations to consolidate and compete on a domestic and cross-border basis within the European Union, are deemed to be more important.

The euro has eliminated an important source of cross-country variation in equity markets within euroland. This paper investigates country and industry effects in stock returns during the first year of EMU. In contrast to pre-EMU studies, I find that country effects are much less important than they have been in the past, suggesting that monetary union has stimulated the integration of European financial markets. During 1999, the absolute country effect on stock returns averaged 1.36, compared to 2.42 for the average absolute industry effect. The empirical results highlight the importance of choosing a narrow industry classification when measuring industry effects.

Using five-minute index data from three major countries, i.e. the U.S., the U.K., and Canada, we investigate the pattern of cross-border transmission of stock price innovations during the overlapping trading hours, i.e. 9:30 a.m. to 11:30 a.m. in EST. A Sim's test indicates that the U.S. stock market leads the U.K. market by five minutes and the Canadian market by fifteen minutes. Second, the U.S. stock market price is found to cause both the Canadian and U.K. market prices in the Granger sense, with little or no feedback received from either foreign market. Third, an extended-hours analysis of intra-day interactions between the U.S. and Canadian markets reveals a reverse J-curve pattern.

This paper outlines the organization structure of the European System of Central Banks, comprised of the European Central Bank and the central banks of European Monetary Union member countries. Also outlined are the policy procedures used by the European Central Bank as it implements a common monetary policy for all member countries. These procedures are viewed in comparison to those used by the Federal Reserve System in the U.S.

Optimal monetary and fiscal policies within the European Economic and Monetary Union (EMU) are determined by simulating a global model under alternative assumptions about the objective function of the European Central Bank (ECB) and about cooperation vs. non-cooperation with fiscal policy-makers. In particular, strategies involving: (a) a money supply target, (b) tracking European inflation, (c) stabilizing European nominal income, and (d) fixing the exchange rate of the Euro with respect to the Dollar are evaluated and compared with respect to the associated welfare effects. The results show the high effectiveness of fixed rules in the presence of supply side shocks and the usefulness of cooperative discretionary measures against demand side shocks. Nominal income targeting by the ECB has to be regarded as inferior to inflation targeting, while fixing the exchange rate leads to quite satisfactory results in most cases.

This chapter assesses the feasibility of monetary union in other parts of the world, other than Europe. The major issues examined in relation to forming a monetary union are national sovereignty, seigniorage revenues, uneven economic growth and stability of currency unions. Dollarization is considered as an alternative to and a catalyst for currency union in Latin America. This chapter concludes that monetary union is unlikely to come about outside Europe because of a lack of an institutional framework and commonality. In addition, economic shocks are unlikely to be dissipated symmetrically, which is a major requirement in currency union formation.

This paper examines the feasibility of a monetary union expansion which is desirable for both the entering country and the existing union members. The paper concentrates on the fact that the outside country is likely to be small relative to the existing monetary union, and lack the resistance to inflation which comes with market power in trade. Consideration of this market power effect allows for mutually-desirable entry if the outside nation central bank is moderately more averse to inflation than the central bank of the existing monetary union.

This paper examines how the formation and implementation of the Eurosystem correlates with benefits to be gained from cooperation with members along with competition with the U.S. and the Rest of the World (ROW). The findings suggest that protectionism is the dominant reason for the creation of the European Union (EU). Both the total gains for member countries from groupings such as the Eurosystem or NAFTA are greater than the sum of the gains each member can command individually. Profits, therefore, remain the driving force behind the formation of the European Monetary Union.