西非國家經濟共同體使用單一貨幣之前景-從歐元區之經驗分析 - 政大學術集成

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(1)應用經濟與社會發展英語碩士學位學程 International Master's Program in Applied Economics and Social Development. 碩士論文 Master’s 治 Thesis. 立. 政. 大. ‧. ‧ 國. 學. 西非國家經濟共同體使用單一貨幣之前景 -從歐元區之經驗分析. n. er. io. sit. y. Nat. The Prospect of a Common Currency for the Economic Community of West African States: Lessons from a the Eurozone Experience iv l C hengchi Un. Student: Asma Amina BELEM Advisor: Tsoyu Calvin LIN. 中華民國 106 年 6 月 June 2017. 1 | P a g e.

(2) Acknowledgements This work would not be complete without the help of so many people. Here I would like to mention specifically Professor Tsoyu Calvin LIN. He was always willing to guide and help me improve the quality of this work. More importantly, Professor LIN was approachable and available. He has given his support whenever it was needed. I feel very fortunate to have had him as a supervisor and thank him very much for his support. My family, more than anyone else has been supportive and encouraged me throughout this. 政治大. journey. They have taught me to go beyond my limitations, instilled me values and morals,. 立. and kept believing in me. I am truly grateful to them.. ‧ 國. 學. I was lucky to be granted the Taiwanese government scholarship. This scholarship helped. ‧. me to finance my master degree studies; I had the chance to discover Taiwan, learn Chinese,. y. Nat. and established new connections. This experience will certainly bring me much more. er. io. sit. fortune in the future. I am very grateful to my country Burkina Faso and Taiwan for giving me such an incredible opportunity.. n. al. Ch. engchi. i n U. v. During the process of writing the thesis, my friends, classmates and country mates have helped me a lot with proofreading, statistics software, suggestions, encouragement and much more. I thank all of them for their help. I have appreciated it a lot.. 2 | P a g e.

(3) Abstract This study aimed at contributing to the debate of monetary integration in West Africa by using the Eurozone experience as a benchmark to study the ECOWAS prospective single currency project. We found that while the precursors of monetary union theory focused on labor mobility, financial integration, openness, etc. as the preconditions to establish a common currency, payment imbalance, unsustainable external and public debt, private sector credit boom were the main causes of the Eurozone sovereign debt crisis. Furthermore, the Eurozone experience shows that the monetary. 治政 mechanism of resolution of the debt crisis shows that a 大 monetary union must always be 立 accompanied by some degree of fiscal and banking union or at least a strict coordination of. union increases countries’ vulnerability to international movements. Lastly, the Eurozone. ‧ 國. 學. macroeconomic policies. The ECOWAS countries have for the great majority structural current account deficit, high external debt and rely on commodities export. This situation point out a. ‧. problem of competitiveness, a reliance on external capital and a vulnerability to changes on. Nat. sit. y. commodities prices. We argue that it is imperative for the ECOWAS to solve these competitivity. al. er. io. issues throughout a diversification of the economy, a promotion of small and medium enterprise. v i n C hexternal debt, currentUaccount deficit and an indicator that the convergence criteria a benchmarked engchi n. and implementation of import substitution policies. Additionally, the ECOWAS should include in. captures the vulnerability to financial integration. Finally yet importantly, the ECOWAS should. accelerate the creation of the common currency otherwise, the various postponements of the launch of the regional currency might discourage the local participants and pose doubt about the credibility of the ECOWAS.. Key words: common currency, ECOWAS, Eurozone, debt crisis, financial integration, macroeconomic imbalance.. 3 | P a g e.

(4) Contents Acknowledgements ......................................................................................................................... 2 Abstract ........................................................................................................................................... 3 List of figures .................................................................................................................................. 6 List of tables .................................................................................................................................... 7 Chapter 1: Introduction ................................................................................................................... 8 I.. Research motives ................................................................................................................. 8 . I.. Introduction ......................................................................................................................... 9 . II.. Research question .............................................................................................................. 10 . 政治大. Chapter 2: Literature review and methodology ............................................................................. 13 I.. Literature review ............................................................................................................... 13 . 立. Theoretical literature review .......................................................................................... 13 . 2.. Empirical literature review ............................................................................................ 18 . ‧ 國. II.. 學. 1.. Methodology ..................................................................................................................... 22 . Chapter 3: A Study of the Eurozone .............................................................................................. 25 . ‧. Part I: A Background Study of the Eurozone ............................................................................ 25 Historical background ................................................................................................... 25 . II.. The stabilizer mechanisms of a country not member of a monetary union................... 27. sit. y. Nat. I.. IV.. The Eurozone keys monetary treaty and their limitations ......................................... 31 . al. n. V.. er. Eurozone and the Optimum Current Areas theory .................................................... 28. io. III.. Ch. i n U. v. Overview of the sovereign debt crisis ........................................................................... 35 . VI.. engchi. Proposed solutions by the Eurozone to deal with the crisis ....................................... 39 . Part 2: The episode of the debt crisis: an Empirical study ........................................................ 41 I. Story in pictures: the expectation that monetary unions are balance of payment crisis free has not been meet ........................................................................................................... 41 II.. Variable setting .............................................................................................................. 47 . III.. Specification of the model ......................................................................................... 50 . IV.. Results ....................................................................................................................... 51 . Summary ................................................................................................................................... 55 Chapter 4: The Economic Community of West African States ..................................................... 57 I.. Historical and institutional background ............................................................................. 57 1.. Historical background ................................................................................................... 57 4 | P a g e.

(5) 2. II.. Institutional background ................................................................................................ 59 Macroeconomics imbalance, regional disparity ................................................................ 61 . 1-. Analysis of ECOWAS’s member countries inflation .................................................... 61 . 1-. Analysis of ECOWAS member states’ current account ................................................ 63 . 2-. Analysis of ECOWAS countries’ External debt to Export ratio ................................... 66 . III.. Convergence in ECOWAS ............................................................................................ 69 . III.. Others potential challenges of the common currency project ....................................... 76 . Summary ................................................................................................................................... 77 Chapter 5: Conclusion and Policy implications ............................................................................ 79 I.. The Eurozone experience versus the ECOWAS situation: a comparative analysis .......... 79 . II.. Policy implications ............................................................................................................ 83 . 政治大. III.. Conclusion ..................................................................................................................... 86 . IV.. Limitations ..................................................................................................................... 87 . 立. ‧. ‧ 國. 學. References ......................................................................................... Error! Bookmark not defined. . n. er. io. sit. y. Nat. al. Ch. engchi. i n U. v. 5 | P a g e.

(6) List of figures Figure 1: Yearly inflation differential and average change in relative unit labor cost from 2002 to 2008 ..................................................................................................................... 31 Figure 2: selected Eurozone countries current account from 1999 to 2014 ..................... 38 Figure 3: Evolution of selected Eurozone countries macroeconomic indicators .............. 44 Figure 4: ECOWAS average consumers price.................................................................. 63 Figure 5: ECOWAS countries current account as percentage of the GDP ....................... 64. 政治大. Figure 6: ECOWAS external debt to Gross National Income and external debt to Export. 立. ........................................................................................................................................... 68 . ‧. ‧ 國. 學. n. er. io. sit. y. Nat. al. Ch. engchi. i n U. v. 6 | P a g e.

(7) List of tables Table 1: Descriptive statistics of the spread ..................................................................... 48 Table 2. Descriptive statistics of all the variables............................................................. 50 Table 3: Regression output ............................................................................................... 54 Table 4: Current account balance as percentage of the GDP, computation of the mean and standard deviation ............................................................................................................. 66 Table 5: Means and Standard deviation of the external debt to export ratio .................... 69. 政治大. Table 6: Countries’ performance on convergence criteria ................................................ 75. 立. Table 7 Summary similarities and differences between the Eurozone and ECOWAS .... 82 . ‧. ‧ 國. 學. n. er. io. sit. y. Nat. al. Ch. engchi. i n U. v. 7 | P a g e.

(8) Chapter 1: Introduction I.. Research motives. The Economic Community of West African States has long been seeking economic and monetary integration. As a matter of fact, the west African countries have agreed on adopting a common currency a long time ago as the original launch date of the ECOWAS common currency was 1994. The various postponements of this project not only illustrate the unreadiness of the West African countries but also essentially point out their economic. 政治大. difficulties. This study aims to contribute to the economic development of West Africa by. 立. proposing policy recommendations that can help solve the prevailing economic and. ‧ 國. 學. monetary integration problems within that region.. Many studies have examined the feasibility of the ECOWAS single currency project based. ‧. on the Optimal Currency Areas theory and using the Vector Auto-Regressive model. This. y. Nat. sit. study tries the unconventional way by using the Eurozone experience as a benchmark to. n. al. er. io. study the ECOWAS single currency project. The Eurozone is one of the biggest monetary. i n U. v. unions in the world. Its, currency the Euro, is one of the biggest international currency in. Ch. engchi. the world as well. More importantly, the recent developments such as the debt crisis, Brexit, and Frexit have revived the debate on monetary unions and given much public attention to this region. Thus, the least we can get by studying the Eurozone is everything we need to know about monetary unions. By doing so, we intend to bring to light patterns that previous studies have not identified, thus enabling the provision of useful policy recommendations.. 8 | P a g e.

(9) Besides the aforementioned, the choice of this research topic is the result of the researcher’s passion for the study of macroeconomics and international finance and her desire to pursue further studies in this area. This study represents for her a step forward in the direction of her long-term career goal. . I.. Introduction. The Economic Community of West African States (ECOWAS) seeks to promote economic integration in all areas thereby ensuring a collective self-sufficiency of its member states1.. 政治大 currency by 2020. In 40 years 立of existence, the regional economic community has made a To achieve this goal, one of ECOWAS the key strategies is the implementation of a single. ‧ 國. 學. lot of progress; however, the conditions for establishing a regional single currency seem to not be met yet, as witnessed by various studies on the topic. Up to the present, the Eurozone. ‧. is one of the biggest monetary unions in the world. Today, the Euro stands as the world’s. sit. y. Nat. second most important international currency2. Along its path of existence, the Euro has. al. er. io. encountered moments of prosperities as well as periods of difficulties (Bamituni, 2013).. v i n C currency. The purpose of this study ishtoecontribute to itheU n g c h debate of single currency in West n. As such, the Euro experience can serve as a reference for the ECOWAS prospective single. Africa and provide policy recommendations to the ECOWAS by using the Eurozone experience as a benchmark.. 1. (ECOWAS, 2017) About the ECOWAS: Basic information. Retrieved from http://www.ecowas.int/ (EU, 2017). About the EU: EU monetary cooperation. Retrieved from https://europa.eu/europeanunion/index_en 2. 9 | P a g e.

(10) II.. Research question. The ECOWAS was established in May 1975 through the treaty of Lagos and is composed of fifteen countries gathered in two groups of regional economic community: the West African Economic and Monetary Union (WAEMU) and the West African Monetary Zone (WAMZ)3. The WAEMU countries are Benin, Burkina Faso, Cote d’Ivoire, Guinea Bissau, Mali, Niger, Togo, and Senegal; the WAMZ countries are Ghana, Gambia, Guinea, Liberia, Nigeria, and Sierra Leone. Cape Verde is the only country in the ECOWAS that is neither. 政治大 economic and social challenges and, up to date, remain ones of the world’s least developed 立. member of the WAEMU nor of the WAMZ. The ECOWAS countries are faced with. countries. However, they are fast growing 4 , and have many potentialities such as. ‧ 國. 學. endowment in natural resources, young population, and industries in await to be exploited.. ‧. The economic integration sought by the ECOWAS can unleash these potentialities thereby. sit. y. Nat. ensuring sustainable economic development. Nevertheless, the formation of a monetary. al. er. io. union is a tremendous shift. If well implemented, its outcomes are undoubtedly favorable.. v i n C h integration, U foreign direct investment, enhance political e n g c h i etc. (Mongelli, 2008). However, a n. For instance, a monetary union can eliminate exchange rate costs; develop trade, increase. single currency can have deleterious consequences if the member states involved do not fulfilled the condition for its establishment (Gnimassoun, 2013). Called the European Union (EU) since 1993, the EU has been created in 1958 and was initially named the European Economic Community (EEC)5. The name change reflects the. 3. (ECOWAS, 2017). About the ECOWAS: Basic information. Retrieved from http://www.ecowas.int/ According to the ECOWAS, in 2013 the West Africans countries have registered on average an economic growth rate of 6.3% 5 (EU, 2017). About the EU: EU in brief. Retrieved from https://europa.eu/european-union/index_en 4. 10 | P a g e.

(11) shift from economic union to political union6. The Euro was launched in January 1999. Today, 19 countries out of the 28 that make up the European Union have adopted the Euro. From the sovereign debt crisis to “Brexit”, the European Union story is rich in lessons that ECOWAS in its pursuit of monetary integration can learn from not only in the formulation and conduct of their policies but also in setting up discipline and measures to overcome potential future crisis. In this study, we intend to establish a concrete analysis of ECOWAS’ situation, to study. 政治大 these analyses, we aim to provide policy recommendations for the ECOWAS single 立. the Eurozone’s recent monetary problems, and its main monetary treaties. As the result of. ‧ 國. 學. currency project. As such, our main question is the following: What lessons do we learn from the Eurozone experience for the prospective West African monetary union? The. ‧. following specific questions will be addressed in this study:. Nat. y. What have been the main mistakes in the design of the Eurozone common currency?. sit. . al. n. . er. io. Does the ECOWAS presents features that might lead to similar mistakes?. i n U. v. What were the main causes of the Eurozone debt crisis? Does the ECOWAS present. Ch. engchi. peculiarities that might lead to unsustainable public debt and an eventual debt and currency crisis? . Does the ECOWAS fulfill the conditions to have single currency? What do the empirical studies tell us about the sustainability of the prospective West African single currency?. 6. Ibid. 11 | P a g e.

(12) In the next chapter, we will present the theoretical and empirical literature review combined with a detailed explanation of the methodology we have used in this study. Chapter 3 is dedicated to the study of the Eurozone. This study is divided in two parts: a case study of the Eurozone’s main issues and a quantitative empirical study of the Eurozone debt crisis. In chapter 4, we study the ECOWAS in reference to our findings about the Eurozone. We will compare and contrast the Eurozone experience and the ECOWAS situation in chapter 5 in other to provide an apprehension of the big picture to the reader. Additionally, in the same chapter, we provide the general conclusion and policy recommendations to the ECOWAS.. 立. 政治大. ‧. ‧ 國. 學. n. er. io. sit. y. Nat. al. Ch. engchi. i n U. v. 12 | P a g e.

(13) Chapter 2: Literature review and methodology I.. Literature review. 1. Theoretical literature review The most commonly referred monetary union theory is the theory of Optimal Current Area (OCA) developed by Robert A. Mundell (1961). The theory received significant contributions from mainly two other authors: McKinnon (1963) and Kenen (1969). In this. 政治大. section, we will elaborate chronologically on the work of each contributor.. 立. Factor mobility. 學. ‧ 國. . Mundell (Mundell, 1961) intends to propose a practical solution to the recurrent issue of. ‧. balance of payment crisis; crisis that he believes is caused by the fixed exchange rate regime system, price and wage rigidity. He aimed to propose the conditions that make a. y. Nat. io. sit. region suitable to be a currency area: an optimal currency. Note that his argument implicitly. n. al. er. stipulate that an optimal currency area is a single or multiple currencies using area under a. Ch. i n U. v. fixed exchange rate regime that can simultaneously provide the ultimate goal of price. engchi. stability, external balance and circumvent unemployment. First, considering a currency area with multiple currencies. If a single entity in this zone faces a negative demand shock – shift of its demand toward the other countries’ goods, its unemployment level will increase7. To resolve this issue, other countries must be willing to inflate, therefore causing a depreciation of the country’s currency, restoring its external accounts equilibrium and. 7. This situation implies an asymmetry of shocks within the region. 13 | P a g e.

(14) dissolving unemployment8 . Second, on the contrary, considers a single currency using currency area. In that region, if one single entity attempts to dissolve its unemployment with expansionist monetary policy, the inflationist pressure will be transferred to other entities not concerned with the issue of unemployment. To sum up any of these types of currency areas cannot restrain at the same time unemployment and inflation. A trade-off has to be made. Even if two countries are in a flexible exchange rate system, but their national boundaries cover overlapping regions, a shift of regional demand, still implies an adjustment process that involves a trade-off between unemployment and inflation. 治政大 Therefore, it is natural to especially if factors of production are internationally immobile. 立 agree that if the currencies were region-based rather than country-based and the regions. ‧ 國. 學. were in a system of flexible exchange rate regime, with very little mobility of factors of. ‧. production across regions as well, the issue of trade-off between inflation and unemployment will be resolved. What kind of region is adequate to have a single currency?. y. Nat. io. sit. Well, Mundell argues that the currency areas cannot thinly be conceived to reflect the. n. al. er. factors mobility within a region. If that were the case, the numbers of currency areas would. Ch. i n U. v. be enormous, considering exchange rate cost and the argument in favor of flexible. engchi. exchange rate regime9 that would be economically inefficient. However, Mundell sum ups by arguing that single currency should be adopted in areas within which factors are mobile inside and outside of which factors are immobile. Since a country currency’s represent its. 8. Note that if surplus countries are not willing to inflate that is letting currency appreciate as result of the increase in their demand, the adjustment in deficit countries will not be possible. 9 The argument in favor of flexible exchange rate regime states that people tend to resist a direct negative monetary change in wages and prices but would accept the same if it occurs through appreciation of domestic currency. Thus, this argument will be questioned if the number of the world currency is so high that the numbers of imported goods in a country domestic consumption is extremely high.. 14 | P a g e.

(15) sovereignty, the region adopting the single currency must preferably a be country or a group of countries willing to give up on their national sovereignty. . Integration of openness, inter-sectorial factor mobility. McKinnon (1963) expand Mundell idea of optimal currency area by examining the impact of openness on domestic price stability and the conditions the conditions under which monetary and fiscal policy will be effective. Note that the share of tradable goods (imports and exports) in once domestic product measures the degree of openness.. 治政 He argues that the more a country is open the more flexible 大 exchange rate regime is 立 ineffective to reestablish the external balance and stabilize domestic price. In fact, in an ‧ 國. 學. open economy, variation in the international price of tradable goods are rapidly spread out. ‧. to the domestic living cost (including the price of non-tradable goods). An open economy with flexible exchange rate regime when facing undesirable movement in the exchange. y. Nat. io. sit. rate should reduce expenditure through monetary and fiscal policy to improve trade balance.. n. al. er. However, if the economy in question was very close that is produces a huge amount of. Ch. i n U. v. non-tradable goods but very little tradable goods then, the best solution here is to let the. engchi. price of tradable goods float based on the change of exchange rate10 and to fix the domestic price of non-tradable goods. In this way, a depreciation of domestic currency will increase the price of tradable goods thus stimulating its domestic production. Further, McKinnon proceeds by examining the monetary implication this theory because as he mentioned, efficient adjustment of external balance rests on the degree of fluctuations. 10. If a country is very small, the price of its tradable goods is highly determined by foreign prices, thus making fiscal and monetary policy very ineffective to change the term of trade.. 15 | P a g e.

(16) of domestic price level thus the “money liquidity value”. His findings are the following: (i) For large economies with relatively high non-tradable good, either pegging the domestic currency to the price of non-tradable goods or flexible exchange rate regime will confer price stability. (ii) Small and open economies, which trade among themselves, should opt for a fixed exchange rate regime in order to ensure a stable money liquidity value of each of their individual currencies. (iii) For a small and open economy whose domestic currency is not pegged to that of the larger economy11, its currency value tends to be less than that of the larger economy. Thus it will be facing capital outflow toward the larger country, in. 治政大 balance of payment deficit. such a way that the small country finances the large country’s 立 This implies that the flexible exchange rate regime is only suitable for countries that have. ‧ 國. 學. their currency value about the same as the outside major currencies money liquidity value.. ‧. (iv) When two economies (in flexible exchange rate regime) currencies’ value is about the same, capital flow among the two will relatively small because there is no potential gain. y. Nat. io. sit. from changing one currency to the other especially if we take into account exchange rate. n. al. er. cost. Thus if the world was to be divided in optimal currency areas, all opting for a floating. Ch. i n U. v. exchange rate regime, each area would be able to safely conduct monetary policy without. engchi. experiencing capital movement as a result.. In his conclusion, McKinnon recognized that even though factors mobility is the necessary condition to group the world into common currency areas, the single currency itself will trigger a greater factor mobility. In addition, if we consider the mobility of factors across industry, McKinnon’s analogy suggests that the grouping of countries into single currency. 11. We supposed that the world is composed of two economies here, the small and open country and the large and open country.. 16 | P a g e.

(17) area should happen geographically rather than industries-based. However, he did provide an example of a situation where common currency areas with regional and industrial factor mobility could survive. . Diversification of the economic activity. Kenen (1969) intend to prove that Mundell argument is missing some crucial elements or at least one. First, He argues that if there is a dissimilarity in the labor intensity of each sub-region in the domain of the currency area, labor mobility despite the fact that can solve. 政治大. unemployment might cause an imbalance in the labor market of each sub-region and there. 立. is no guarantee that factor movement can ensure a reestablishment of the external balance.. ‧ 國. 學. Second, to avoid possible conflict between the objectives of monetary and fiscal policy, the two should be operating side by side, and more importantly, the domain of the fiscal. ‧. policy should be similar to the domain of the currency areas. Third, given the fact that the. Nat. sit. y. government aims to minimize expenditure/cost, the currency area should remain within the. n. al. er. io. realm of the of the least cost government. That condition implies that the currency areas. i n U. v. should be composed of as many as possible single product areas. According to Mundell,. Ch. engchi. this economic diversification does not confer the currency areas its optimality, however Kenen argues that this not only ensure fiscal efficiency but also guarantee the labor mobility sought by Mundell. For Kenen, diversity of the economic activity is the main condition that makes a region an optimal currency area. Three main arguments support Kenen claim. First, a well-diversified economy will not be subject to frequent change in the term of trade. Second, its employment does not vary significantly as a result of change in the export demand. Third, in such an economy, the link between investment and export is weak so that a decline in 17 | P a g e.

(18) the export might not affect significantly capital formation. Additionally, as the author argued previously, the diversification of economic activity is the pre-condition to have strong-intra regional labor mobility. These three criteria are not all the Optimal Currency Areas theory properties. The theory emerged and received the contribution of many other scholars. For instance, Ingram12 (1962) added an extra property to the OCA theory: financial integration. He claims that financial integration minimize the necessity for exchange rate correction throughout. 政治大 higher the degree of financial integration the more rapid is the transmission of monetary 立 borrowing and lending respectively from surplus and to deficit countries. Additionally, the. ‧ 國. 學. policy. Amongst the seminal contributors we can cite Fleming (1971) with his “similarity of participating countries inflation rate”, Kenen (1969) work on the necessity of fiscal. ‧. transfer mechanism to facilitate adjustments to shock in currency areas, Mintz (1970),. sit. y. Nat. Haberler (1970) and Willet (1979) study on the importance of political integration for a. io. al. er. currency areas, Frankel and Rose (1998) with trade and economic integration, similarity in. n. business cycle etc. These contributions to the OCA theory are worth mentioning, but for. Ch. engchi. space consideration, we will not explore them in debt.. i n U. v. 2. Empirical literature review Numerous researches have used the Optimal Currency Areas (OCA) theory developed by Mundell (1961) to study the feasibility and sustainability of common currency in West Africa as well as in Europe. Despite the fact that the OCA theory lays the foundation for the study of the feasibility of monetary unions, it is limited. For instance, Mongelli (2008). 12. We will talk more about Ingram and financial integration in chapter 3. 18 | P a g e.

(19) stresses the endogeneities of optimal currency areas. That is a group of countries not fulfilling at the OCA theory conditions’ for the establishment of a monetary union can become an OCA after the adoption of the single currency. The reasons advanced are the facts that the single currency by enhancing economic and financial integration will cause a business cycle synchronization. Ndiaye and Korsu (2014) investigated the degree of nominal and real convergence among the ECOWAS countries. As for real convergence test they used the deviation of real GDP. 政治大 convergence. They found that there is a partial convergence of exchange rate, reserve of 立 from its trend. Unit roots test and cointegration were the statistical tools used to test for. ‧ 國. 學. money within ECOWAS as a whole, the WAMZ, the WAMZ plus Cape Verde as well. A partial real convergence that is convergence of business cycle was found within ECOWAS. ‧. as a whole, the WAMZ, the WAMZ plus Cape Verde as well. As for WAEMU plus Cape. sit. y. Nat. Verde, there was a complete convergence of exchange rate. These results suggest that. io. al. er. WAMZ and ECOWAS as a whole fulfilled the conditions to have common currency. However, they have found no convergence of exchange rate, reserve of money, interest. n. v i n rate as well as on the indicator ofC realhconvergence between e n g c h i U WAEMU and any of the nonWAMZ countries. This implies that it will not be ideal for any of the non-WAEMU countries to individually join the WAEMU monetary union. These authors recommend that the individuals’ national parliaments and ECOWAS parliament should make sure that the fiscal budget deficit convergence is fulfilled by ECOWAS member states13. Additionally, they urge the prospective ECOWAS central bank to have for ultimate goal low and stable. 13. Note that they could not test for fiscal convergence in the ECOWAS region because only Sierra Leone and Nigeria had non-stationary series.. 19 | P a g e.

(20) inflation. Furthermore, as there is no convergence of interest rate among the WAMZ countries (without Nigeria) and WAMZ plus Cape Verde, they suggest that the ECOWAS countries should have a common money market and a common monetary policy rate. Mougani (2014) assessed the current monetary coordination and financial integration within the WAMZ and the East African Community (EAC). He argues that despite the fact that East and West Africa have made progress in terms of economic integration, their economic convergence and financial integration progress have been slow. He claims that. 政治大 monetary union. Therefore,. the Eurozone experience suggests that monetary cooperation and financial integration are. 立. crucial for the success of a. the author recommends. ‧ 國. 學. strengthening the monetary cooperation between the institutions and the member countries individual central banks of East and West African RECs. This can be done through. ‧. ensuring an adequate degree of trade, reinforcing the financial system. Further, he argues. sit. y. Nat. that the continuous postponement of the monetary union project will diminish the. io. al. er. credibility of these institutions and deteriorate the support of market participants and the. n. general public. Thus, the RECs should set gradual and realistic goals.. Ch. engchi. i n U. v. Agyapong (2012) explores the Eurozone currency crisis and proposes some solutions for the WAMZ. His analysis suggests that the WAMZ model of introduction of single currency is similar to that of the Eurozone in the sense that the admission to the monetary union is based on the fulfilment of the preset convergence criteria. According to the author, macroeconomic mismanagement, rising government debt level, trade imbalance, loss of confidence and lack of transparency in some countries are the main causes of the Eurozone debt crisis. The author stresses that a common political and financial standing is imperative for a monetary union to be vital. Fiscal transfer is necessary – that is, strong economies 20 | P a g e.

(21) have to support weaker economies to avoid contagious crisis. He goes further by arguing that the WAMZ should pay attention to new occurrences on the financial market that can cause crisis and in order to ensure countries transparency, a common macroeconomic estimation methodology should be imposed by the WAMZ to avoid potential currency crisis. Lastly, he asserts that the WAMZ countries should pursue similar economic and financial policies in order to ensure a smoother transition to the common state. Masson and Pattillo (2003) aimed to find out whether or not monetary union can lead to. 政治大 empirically and from the European Monetary Union (EMU) and WAEMU experience 立 more fiscal disciple from the part of the participating countries. Their findings both. ‧ 國. 學. suggest that a regional common currency tends to increase the incentive for fiscal misconduct. They argue that in order to make the common currency project a successful. ‧. one, it is important that the ECOWAS becomes an effective agency of restraint for fiscal. sit. y. Nat. policy. They recommend that the fiscal authorities be independent from the counties. io. n. al. er. accession to the union throughout their life in the union.. i n U. v. The quality and the usefulness of the outcome of these previous studies are undeniable.. Ch. engchi. However, most of them focus entirely on ECOWAS, or the WAEMU or the WAMZ but not the combined Eurozone-ECOWAS. Although two studies elaborated on Eurozone debt crisis experience and have provided policy recommendations to the WAMZ, the sustainability of ECOWAS prospective single currency has not been evaluated in reference to Eurozone experience as a whole. Additionally, these two studies have not done an empirical study of the Eurozone but mostly relied on previous literature to evaluate its experience. Here, not only we have revised the literature on the Eurozone, but also we designed and estimated a model to analyze the Eurozone debt crisis. Our research is very 21 | P a g e.

(22) innovative in the sense that we try to conciliate two Regional Economic Communities with different economic and historical backgrounds but having in common a desire to have a better monetary integration. Additionally, the majority of these studies do not provide a detailed explanation of why certain ECOWAS countries are facing particular economic issues. We believe that these details are very important in order to understand the ECOWAS issues and provide useful recommendations. Therefore, in this research paper, we have provided a background study of all the ECOWAS countries that are facing economic and financial issues and failing to meet the conditions to have a common currency.. Methodology. ‧ 國. 學. II.. 立. 政治大. This research is an empirical study using both quantitative and qualitative methodological. ‧. approaches. Our qualitative approach consisted essentially of case studies of both Eurozone. sit. y. Nat. and ECOWAS. We have reviewed the existing literature and documentations on the. al. er. io. Eurozone in order to grasp an understanding of the prevailing patterns, the recent. v i n C h insight into the Eurozone study of the Eurozone provided us with problems, which in turn engchi U n. developments and the current economic and monetary situation of the sub-region. The case. allowed us to emit and test quantitatively hypothesis about the debt crisis. More specifically, we have used the statistical software STATA to estimate our PROBIT model which, provides the determinants of the probability to experience financial distress in the Eurozone. Based on the patterns found on the Eurozone from both our case study and our quantitative study, we have completed this research investigating whether or not the ECOWAS presents similar or closely similar patterns as the Eurozone. This has been done throughout the analysis of ECOWAS macroeconomics data. Additionally, we have examined whether or 22 | P a g e.

(23) not the ECOWAS countries fulfilled the convergence criteria set by the ECOWAS and we provided a detailed explanation of why certain countries failed to meet such criteria. To summarize we have done a comparative analysis of the two Regional Economic Communities. The combination of the review of existing documentations with the analysis of macroeconomics data and the estimation of PROBIT model permit us to avoid possible difficulties of finding enough studies and to overcome the scholar opinion bias coming from previous studies. The macroeconomics data used have been collected from the World Bank, the International Monetary Fund, the Eurostat and ECOWAS database. Some have. 治政 been retrieved directly from the IMF yearly outlook 大 of the two Regional Economic 立 Communities. The World Bank, the International Monetary Fund and Eurostat data have. ‧ 國. 學. been selected because they are among most credible economic and financial institution in. ‧. the world, thus provide credible data as well. The empirical studies that we reviewed methodologies’ vary from on another whether it is qualitative or quantitative. Target. y. Nat. io. sit. macroeconomic variables and empirical studies have been chosen and analyzed from the. n. al. er. theoretical perspective of monetary union establishment and based on the relevance of the findings of the studies as well.. Ch. engchi. i n U. v. This approach fits perfectly our research question, which is to provide policy recommendation to ECOWAS single currency project based upon Eurozone experience. In fact, numerous quantitative studies have examined the feasibility of this project using OCA theory and vector Auto Regression (VAR) model. These studies are able to answer whether or not to form a monetary union in West Africa based on a single aspect, which is the uniformity of the member states’ business cycle. However, fiscal transfer mechanisms, labor mobility, openness are also crucial factors to consider when deciding to form a. 23 | P a g e.

(24) monetary union. For instance, the most cited cause of the Eurozone debt crisis is macroeconomics imbalance and sudden stop of capital inflow. However, these factors have not been predicted by the previous literature on currency areas. Some other studies have used the Behavioral Equilibrium Exchange Rate (BEER) approach to prove that a nonoptimal currency area can be sustainable. Here we combine the outcome of these studies with the analysis of macroeconomic data, a case study of the Eurozone and a quantitative empirical study to provide policy recommendations to ECOWAS. In this way, we are able to explore not all but the most important aspects of monetary union and gain insights into. 治政大 and formulate practical the major issues that might happen in such an institution 立 recommendations for West African Regional Economic Community.. ‧. ‧ 國. 學. n. er. io. sit. y. Nat. al. Ch. engchi. i n U. v. 24 | P a g e.

(25) Chapter 3: A Study of the Eurozone Part I: A Background Study of the Eurozone I.. Historical background. In the beginning, the primary purpose for establishing the European Union was to promote peace and social cohesion in a divided and destroyed Europe by two world wars (Dinan, 2004). As such, the individual countries will give up part of their sovereignty and ease. 政治大 World War I, which lasted for more than four years, was fought in great majority in Europe 立 down their nationalist spirit to promote a mutual peace, stability, economic integration, etc.. ‧ 國. 學. (Dinan, 2004). The disastrous consequences of the war released the idea of a European union, more precisely the Pan-Europa promoted by Richard Coudenhove-Kalergi, count of. ‧. the Holy Roman Empire. Pan Europa did not last long time despite the hard work of the. sit. y. Nat. two French politicians – namely Edouard Herriot and Aristide Briand – and the German. io. al. er. Foreign minister Gustav Stresemann to promote the European integration. Afterward, in March 1931, Germany and Austria introduced a proposal for an Austro-German customs. n. v i n C h this proposal raised union open to others countries. However, e n g c h i U the fear of an Austro-German political union leading to its obstruction by France. The years 1930s were characterized a. recession and upsurge of the war in Europe. In order to stop the communist aggression of Western Europe, the United States was very involved in the post-World War European political matters. Federalist ideology was appealing to the liberated Europe. The environment and circumstances seemed favorable for European integration, an integration build on the rule of law and share sovereignty. As a result of the cold war, that integration was restricted only to Western European countries. The French Foreign Minister, Robert. 25 | P a g e.

(26) Schuman, undertook the very first initiative in 1950 where he made declaration that has led to the establishment of the European Coal and Steel Community (ECSC) 14 . The aggravation of West-East conflict, the challenges to Germany recovering after the war, and the postponement of U.S, French and German national goals made the Schuman declaration the best response to the situation. The founding father of EU did not seek to set supranational political entities but rather agreed to share sovereignty in particular areas, therefore ensuring that the creation of the European Community (EC) goes in line with the reinforcement of individual of national states (Dinan, 2004). The call on greater economic. 治政 integration namely the rapid increase of intra-Europe 大 trade led to the creation of the 立. European Economic Community. French president and German chancellor were. ‧ 國. 學. considering a possible monetary policy cooperation among EC countries. Jacques Delors,. ‧. the EC commission president made sure that the single market program include section dedicated to collecting of funds to support the economic development of poorer countries. y. Nat. io. sit. within the EC: the structural fund. The Single European Act has been the first crucial treaty. n. al. er. in the EC history. It guaranteed a majority vote of the Council of ministers to speed up the. Ch. i n U. v. launch of the European single market. Note that both the political leaders and the European. engchi. citizens acclaimed the single market program. While Britain was skeptical about the EC and the European integration in general, France and Germany were pushing forward the monetary cooperation plan arguing that it would complement the single market project thereby reinforcing European political cohesion and the decline of the Old Order in Eastern and Central Europe was an opportunity to seize. The reforms in Eastern and Central Europe and the hope for possible German unification defeated the hostility of the project in. 14. Fontaine, P. (2014). The European Union explained: Europe in twelve lessons. Luxembourg: Publications Office of the European Union, p5. doi: 10.2775/36518. 26 | P a g e.

(27) Germany. The Maastricht treaty is the result of the vibrant negotiation on the establishment of a common foreign and security policy and the creation of the Economic and Monetary Union. The end of the cold war together with the independence of Eastern and Central European countries has marked an enlargement of the EU. Today the European Union is an economic and political cooperation gathering twenty-eight countries with a population of half a billion people and a combine economy representing 20% of the world total GDP. Out of the 28 countries, 19 are using the common currency,. 政治大 has revived the debate on the common currency areas and more specifically on the 立. the EURO. The 2008, international financial crisis that triggered the Eurozone debt crisis,. ‧ 國. 學. Eurozone. Not knowing specifically what the trigger was, a few years ago, Britain voted a referendum to leave the EU and some political leaders in France are promising a. ‧. referendum on leaving EU to French citizens. With all that being said, the least we can get. y. sit. io. al. n. II.. er. unions.. Nat. from studying of the Eurozone experience is everything we need to know about monetary. i n U. v. The stabilizer mechanisms of a country not member of a monetary union. Ch. engchi. According to De Grauwe (2013), non-member states of a monetary union have got two stabilizer mechanisms that countries in the monetary union do not have or more specifically lose. First, the lender of last resort role of the central bank. The central bank can inject liquidity in the economy in case of crash and panic, conducting the agents to rush for liquidity by selling their assets, pushing assets price down and interest rate high. In reference to the Optimal Currency areas theory, the monetary union by keeping the individual countries to use their lender of last resort role adjusts the asymmetry of shocks throughout labor mobility (Mongelli, 2008). As people migrate from busting countries to 27 | P a g e.

(28) booming countries, the equilibrium is reestablished. However, the labor mobility in the Eurozone is very limited due to the language barrier (O’Rourke & Taylor, 2013). Second, the government itself plays a crucial stabilizer role. In an environment of economic downturn, when the private sector is in the process of reducing its debt by selling assets, the government can stop the deflationist wheel by increasing its borrowing that is issuing more bonds into the market. The central bank’s role expanded to become a commitment toward the government and the. 政治大 engaged in a “deadly embrace” manner (De Grauwe, 2013; Gros, 2015). Supposedly, the 立. bank mainly for two reasons (De Grauwe, 2013). First, the government and the banks are. ‧ 國. 學. government bond price is dropping. This situation will negatively affect the banks because they are the main holders of the government bond. Conversely, if the banks are facing. ‧. troubles and the government wants to support them. It will eventually be faced with. sit. y. Nat. solvency problem. Secondly, the banks and the government have a similar balance sheet. io. al. er. structure. Their liabilities are liquid while their assets are very illiquid. These two. n. institutions are exposed to a great risk of running out of cash. III.. Ch. engchi. i n U. v. Eurozone and the Optimum Current Areas theory. The Optimum Currency Areas theory tells us that a monetary union is suitable for a group of countries, if they have a similar business cycle (O’Rourke & Taylor, 2013). If that is the case, the common central bank can respond to negative or positive shocks easily without harming any single country in the union. If the countries have asymmetric macroeconomic shocks, the common fiscal authority can interfere using fiscal tools to adjust the shocks among the countries in the zone. Additionally, migration from the more prosperous countries to the less prosperous countries – assuming that wage and price are flexible – will 28 | P a g e.

(29) ensure the adjustment in case of negative shock and asymmetry. Conversely, if the region is dealing with asymmetric macroeconomic shocks and has no common fiscal authority to regulate then forming a monetary union will not increase the welfare of the individual member states. Each country would have an individual currency; exchange rate will be the adjustment tools in case of macroeconomics shocks. The Eurozone is a monetary union with no fiscal union, no banking union, and no common political authority (O’Rourke & Taylor, 2013). That is, each individual country within the Eurozone supervises its banking system and conducts fiscal policy independently.. 政治大 O’Rourke and Taylor (2013) in their study “the cross of euros” found the United States 立. ‧ 國. 學. fulfilled more OCA criteria than the Eurozone. As regard with the first OCA criteria: market integration; the intra-Eurozone trade is 17% of the GDP of the region. This figure. ‧. is very low compared with the U.S intra-regional trade, which 66% of the country GDP.. sit. y. Nat. The second OCA criteria: the symmetry of shocks criteria; the correlation between the. io. al. er. Eurozone growth as a whole and the growth in individual Eurozone member countries is 50% as shown by the GDP growth data from 1997 to 2007 in the Eurozone. The labor. n. v i n mobility criterion, the elasticity C of flow among the Eurozone countries shows h e ofn people gchi U that only 14% of the Europeans were residing in countries different from where they were born. The authors point out the divergence of language as drawback factor of labor mobility in the Eurozone. Nevertheless, countries in a monetary union, even if they do not meet the OCA criteria ex-ante can meet them ex-post (Mongelli, 2008). In the EU, the monetary policy is conducted at the union level and the remaining macroeconomic policy is directed at national level. In this situation, there is no channel to make the national dynamic of booms and busts converge at the union level (De Grauwe, 29 | P a g e.

(30) 2013). The monetary union exacerbates boom in booming countries and deepens recession in countries in recession (De Grauwe, 2013). It occurs through the channel of the single interest rate imposed by the European Central Bank (ECB). In fact, the interest rate announced by the ECB is lower than the target in the booming countries and higher than the target of countries in recession. This results in an intensification of the inflation in booming countries. The opposite is observed in countries in recession. For instance, in 2007, a tighter monetary policy was suitable to face Ireland’s housing bubble; however, the country was forced to follow the ECB target, resulting in its banking crisis then. 治政大 to rescue the banks (Frankel, followed by its debt crisis – caused by the government attempt 立 2015). Figure 3.1 shows, that while the southern countries were experiencing a boom –. ‧ 國. 學. high inflation, high labor cost – the northern countries were experiencing “busts”. Very. ‧. few countries were converging at the union interest rate. For instance, using the Taylor rule15, Rourke and Taylor (2013) found that the periphery countries within the Eurozone. y. Nat. io. sit. desired policy rate was 300-point basis above that of the core countries of the zone before. n. al. er. the crisis, after the crisis the periphery desired interest rate was varying between 500 and 700-point basis below.. Ch. engchi. i n U. v. 15. Here the Taylor rule estimate the gap between the central bank target policy rate and a specific countries desired rate.. 30 | P a g e.

(31) Figure 1: Yearly inflation differential and average change in relative unit labor cost from 2002 to 2008. X-axis: average change in relative unit labor Y-axis: yearly inflation differential. 政治大. Source: ECB, Monthly bulletin, November 2012, Retrieved from De Grauwe, 2013. 立. ‧ 國. 學. IV.. The Eurozone keys monetary treaty and their limitations. Nat. sit. y. ‧. 1. The Maastricht treaty. io. er. The Maastricht treaty was signed in February 1992. It has been the forefront of the creation of Euro. The treaty set boundaries that each member should fulfill as requirement in order. al. n. v i n C h Union and useUthe common currency. As such, to be admitted to the European Monetary engchi the Eurozone convergence criteria have been established. The criteria are the following: . The inflation rate of each individual member countries must not be higher than 1.5 percentage point than the top three lowest inflation rate countries.. . Each country government debt to GDP ratio must not exceed 60% and the annual government budget deficit has to be lower than 3% of the GDP.. . Every applicant country is required to join the Exchange Rate Mechanism (ERMII) for two consecutive years and is required to not devaluate during that period. 31 | P a g e.

(32) . The long-term nominal interest rate must not exceed 2 percentage point higher than the three lowest inflation rate member states.. The Maastricht treaty assumed that most macroeconomics policy would be symmetric and could be adjusted by the single monetary policy (Bénassy-Quéré, 2015). As far as the residual asymmetry is concerned, they would be corrected by the stabilizer mechanism in the individual national fiscal policy. Unhappily, that was not the case during the crisis. The single monetary policy of the European Central Bank reached a state close to liquidity trap.. 政治大 situation because individual立 member states were performing a tighter fiscal policy as a. During a period of economic downturn, ECB found itself unsuccessful in correcting the. ‧ 國. 學. whole.. The Maastricht treaty expected financial integration to ensure stability and convergence,. ‧. however, the developments during the debt crisis show that these expectations have not. Nat. sit. y. been met (Bénassy-Quéré, 2015). The capital flowed in periphery Eurozone countries was. n. al. er. io. directed toward non-tradable sector. Sooner, the debt revealed unsustainable because no. i n U. v. counterpart in term of export capacity was being generated. Furthermore, the financial. Ch. engchi. integration played a substantial role in the aggravation of the crisis. By its means, countries experienced the sudden stop in capital inflows. 2. The Stability and Growth Pact (SGP) The SGP is a treaty between the EU members that aim to ensure fiscal sustainability of each and every country in the union. It uses two tools to achieve this purpose. Namely, the preventive arms and the corrective arms (Angerer, 2015). This pact guarantees that individual member states will not comply with the convergence criteria of the Maastricht. 32 | P a g e.

(33) treaty only during their entry to the monetary union but also to keep fiscal discipline after the adoption of the Euro (Kesner-Škreb, 2008). According to Buti et Al (2003), the European Monetary Union’s approach to build fiscal sustainability is much firm than those of the federal countries. The SGP requirements remain the same as the Maastricht treaty government’s finance criteria. The rules are the following: . In case the national debt exceeds 50% of the GDP, the government deficit must be below 3%.. . 學. ‧ 國. . 政治大 these rules can lead to a sanction up to 0.5% of the GDP. Non-compliance with立. GDP growth must be always higher than the growth in the government debt.. Italy has always had a surplus primary balance (except in 2009) yet its national debt has been always extremely high – exceeding the 60% of the GDP – (Karagounis, Syrrakos, &. ‧. Simister, 2015). As a matter of fact, the country’s annually interest rate payment exceeded. Nat. sit. y. the primary balance resulting in a budget deficit and accumulation of debt. Therefore, we. n. al. er. io. can argue that Italy’s excessive debt is not caused by the government’s profligacy but by. i n U. v. large interest payment. Hence, it is hard for the country to meet the SGP criteria. In addition,. Ch. engchi. the country GDP growth has not been strong (0.7% on average) any attempt to implement loose fiscal policy will eventually lead to defying SGP and sanctions by the Eurozone commission would follow. Since 1997, by violating the SGP criteria, Germany has implemented considerable amount of structural reforms to develop its economy (Karagounis, Syrrakos, & Simister, 2015). From 2005, the positive effects of these reforms began to appear – public finance improvement. At the episode of the 2008/09 financial crisis, the German government injected capital in the private and banking industry. The result was a fast recovery from the 33 | P a g e.

(34) crisis, a strong GDP growth. In fact, when the German intra-EU trade declined during the crisis, the country was able to expand its extra-EU trade to mainly emerging Asian market (Karagounis, Syrrakos, & Simister, 2015). According to Boerg and Hallerberg (2016), the SGP has been designed to avoid eventual debt crisis in the Eurozone but it failed as witnessed by the late Eurozone debt crisis. The main goal of the SGP is to maintain deficit low, thus minimizing the risk of debt crisis contagion among countries. The preventive arm of the SGP call for each and every. 政治大 Commission. The European Commission pursues by writing a report of recommendation 立 Eurozone country to submit on a yearly basis their macroeconomic program the European. ‧ 國. 學. for each country that it send to the Council of Economic and Finance Ministers. The latter transfers it officially to the country. The council can qualify a member country of excessive. ‧. deficit based upon the commission counsel. The council can rule upon fining a member. sit. y. Nat. country if it has persistently disregarded the council recommendation – this happens. io. al. er. throughout the commission recommendation to the council. However, since the SGP exists no one state has been fined. Boerg and Hallerberg (2016) argue that, this has not occurred. n. v i n because the countries are capableC and heventually e n g csucceed h i Uto obstruct proposals set against them at the commission level. These two authors used the European Commission proposal of the member states Stability and Convergence Programs and the Council of Ministers editing of it to find that (i) countries with more voting power in the Council of Ministers tend to have positive editing of the Stability and Convergence Program in the Council. (ii) Similar thing occur with countries with Eurosceptic population. (iii) Countries obtain moderate recommendation and get to have more change of their Stability and Growth program if other countries are receiving similar recommendation packages. In other words,. 34 | P a g e.

(35) countries look at each other’s situations when negotiating the change of their Stability and Growth Program. V.. Overview of the sovereign debt crisis. Various explanations have been given to the sovereign debt crisis. Among the causes, the most cited are the governments’s profligacy, private sector excessive leverage, divergence in competitiveness, external imbalance and sudden stop in capital flows (Martin & Philippon, 2014).. 學. ‧ 國. 1.. 治政 Vulnerability of country member of a monetary union 大 to financial market: From “self-fulfilling crisis”立 to solvency issues. According to De Grauwe (2011), “in a monetary union the financial market acquires a great. ‧. power” that is, the monetary union increases the vulnerability of a country to the financial market. Member states of a monetary union issue debt in currency that they do not have. y. Nat. sit. any power over. They cannot guarantee that the cash would be available to pay and extend. n. al. er. io. their debt. Let’s suppose that Spain has issued debt in euros. If the macroeconomic. i n U. v. conditions lead to a fear that creates a panic that Spain might default among the investors;. Ch. engchi. they will sell their holding government bonds. Resulting in a high interest rate of Spanish government bonds. The Euros obtained from the sale of Spanish government bond will be directed to safe countries in the union such as Germany. The total money supply in Spain will decline, causing the government to lack of cash to cover its debt. The high interest rate aggravates the situation by forcing the government to adopt austerity measures. And so goes on the cycle of the recession. The “self-fulfilling liquidity crisis” turned into solvency issue. That has been the case in countries like Portugal, Spain, and Ireland.. 35 | P a g e.

(36) The liquidity issues in these countries have forced their governments to give up on the automatic stabilizers in budget tool (De Grauwe, 2011; De Grauwe, 2013). Furthermore, by channel of the “deadly embrace” the banking industry of EU countries in crisis are threatened (De Grauwe, 2011; De Grauwe, 2013). As the government bond price goes down, the banks’ balance sheet is negatively affected as the government bonds is one of the main components of their assets in the balance sheets. Theoretically, the debtor countries faced by the high market interest rate have no choice but to turn to the creditor countries in the union, which would in turn impose their conditions (De Grauwe, 2013).. 學. ‧ 國. 2.. 政治大 The excessive debt of the private sector as a cause of the debt crisis but not the 立 government debt. De Grauwe (2013) argued that the Eurozone debt crisis was provoked by the private sectors’. ‧. excessive leverage but not the governments as it has been mostly perceived. Before the. sit. y. Nat. debt crisis, the EU member states’ countries private sector was accumulating enormous. io. er. debt. The public sector by contrast was having a declining debt to GDP ratio except Germany and Portugal. When the crisis started, the private in the attempt to deleverage. al. n. v i n C hrecession. The governments would have forced the countries into stepped in by helping the engchi U private to deleverage; the automatic stabilizer in the government budget. That is the. governments have bought the private debt – they purchased the assets sold by the private. Otherwise, if every agent is deleveraging/selling assets, the asset price will go down, and those holding these assets will be faced with solvency problem. The leaders of the Eurozone had a different perception about the root cause of the crisis. They traced the origin of the sovereign debt crisis back to the governments’ excessive spending (De Grauwe, 2013). As De Grauwe argued earlier (2011), such a diagnostic is 36 | P a g e.

(37) true for Greece but not for all the periphery countries in crisis in the Eurozone. For instance, Martin and Philippon (2014) found that the excessive sovereign debt was true for Greece; to a lower extend for Ireland and Spain; however, it was not validated for Portugal. As result of this “misdiagnosis”, these countries have been forced to adopt austerity programs. While the private was still deleveraging the public also did the same, resulting in further drop of assets price and deepening of the crisis (De Grauwe, 2013). According to Frankel (2015), the leaders of the Eurozone and the IMF believed that austerity programs do not reinforce the recession even in the short run.. 政治大 In alignment with De Grauwe’s argument, the findings of Martin and Philippon (2014) 立. ‧ 國. 學. suggest that with the private sector’s excessive debt during the boom, even a more conservative fiscal policy during the same period would have not been enough to restore. ‧. stability. Conservative fiscal policy and macroprudential policy are complementary. sit. y. Nat. (Martin & Philippon, 2014). That is, a fiscal policy directed toward a strict control of the. io. al. er. public debt is not enough by its own to prevent a debt crisis. It must be supplemented with. n. a macroprudential policy – policies aimed at controlling and supervising the financial. i n C sector in order to reduce the risk of the h efinancial hi U n g csystem.. v. 3. The external debt and current account imbalance For Gros (2011), the sovereign debt is caused by a domestic debt (either private or public debt) held by foreigners/foreign countries. Put differently, a country is at risk of defaulting if its government has borrowed from foreign countries. When the residents hold the public debt, even if the country is member of a monetary union – that is, it has no power over the monetary policy – it can still repay all its debt by using the taxing power. The government can issue a new law forcing the citizens to pay more tax. However, if the majority of the 37 | P a g e.

(38) public debt is an external debt and the residents of such a country hold foreign assets, the government is at risk of defaulting because it has limited power to tax foreign assets. Gros (2011) argued that the crisis in Portugal was caused by the private sector taking excessive foreign loans. As the government always steps in, during the crisis to help the private sector, it has taken over the private sector debt. The financial market by considering, the overall indebtedness of the country raise the interest rate. Figure 2: selected Eurozone countries current account from 1999 to 2014. 政治大. 立. 40 20. ‧ 國. 學. 0. 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014. io. Austria Germany. Belgium. Finland. y. year. sit. ‐60. ‧. ‐40. er. ‐20. Nat. percentage of the country GDP. Selected Eurozone countries current account. France. n. Ireland Italy a lGreece v i n C hEconomic Outlook Database, Source: International Monetary Fund, World e n g c h i U April 2016. The Eurozone crisis is a balance of payment crisis that turned into a sovereign debt crisis (Gros, 2015). Independently of the level of their public debt, countries in the Eurozone that had a positive current account in 2008 and/or a positive net external asset did not experience the sovereign debt crisis (Gros, 2015). While Belgium had the highest debt to GDP ratio of the region back in 2008, Spain and Ireland government budgets’ were in consistent surpluses before the crisis. However, Spain and Ireland have encountered the 38 | P a g e.

(39) financial tournament but not Belgium. Before the crisis these two countries real estate sector was booming; a boom financed by foreign capital. The boom became a bust when the foreign capital stopped flowing in – “the sudden stop”. Note that the higher the foreign capital inflow the greater the current account deficit. The longer and the greater is the current account deficit the more profound is the crisis. Above, figure 3.2 shows that the northern countries current account was consistently in surplus while the southern countries’ was in deficit. Note that, the North financed the credit taken by the South (De Grauwe, 2013).. 政治大 Gros (2015) does not throw the blame on the Euro but instead points out the consequences 立. ‧ 國. 學. of a global credit growth and the undercapitalized banks of the Eurozone. The past victory of central banks in stabilizing the economy have led to a belief that business cycle and. ‧. financial risk are gone for good. Global credit growth is the direct effect of such an. sit. y. Nat. optimism. On the other hand, the low capital ratio of banks exacerbated the crisis. io. al. n. VI.. er. throughout their substantial losses of the credit they have issued during the boom.. i n U. v. Proposed solutions by the Eurozone to deal with the crisis. Ch. engchi. 1. The European Financial Stability Facility/European Stability Mechanism To solve the debt crisis, the Eurozone has created the European Financial Stability Facility (EFSF) in May 2010, which has been replaced by the European Stability Mechanism (ESM) since September 2012 (De Grauwe, 2011). This institution main function is to provide financial support to Eurozone member states in difficulties. It is a permanent fiscal transfer mechanism for the European monetary union.. 39 | P a g e.

(40) The EFSF established the interest rate of the funding to Ireland at 6% and a risk premium of 3% above the risk free rate for countries in financial difficulties (De Grauwe, 2011). Such rates not only decreased the private investors’ trust and confidence in these countries capacity to repay their debt – the private lender reacted by increasing their risk premium to event higher rates – but also made it almost impossible for the country to reduce its budget deficit (De Grauwe, 2011). De Grauwe (2011) warns us about certain characteristics of the EMS that might limit its. 政治大 financing rate. Furthermore, the institution will be putting in place a “collective actions 立 own main purpose. The ESM will be setting the interest rate at 200 basis point above the. ‧ 國. 學. clauses” agreement. Put in different terms, the private investors will be asked to share responsibility regarding debtor country losses. These two features of the institution have. ‧. for consequences to make the investors fear and doubt about the solvency of these countries.. sit. y. Nat. As De Grauwe (2011) showed, right after the announcement of the “collective action. io. al. n. Spanish government bond jumped exponentially.. Ch. 2. Outright Monetary Transaction. engchi. er. clauses” by the European Council in October 2010, the spread of Irish, Portuguese, and. i n U. v. The European Committee in 2012 decided to make the ECB the lender of last resort throughout the Outright Monetary Transaction (OMT) program. As a matter of fact, throughout the OMT program, the ECB committed itself to buy as much as necessary Eurozone government bonds during the debt crisis (De Grauwe, 2013). However, it lasted for only a short period.. 40 | P a g e.

(41) Some critics argue that the intervention of the ECB throughout the OMT program has been delayed (Martin & Philippon, 2014; Corsetti, 2015). Has it been initiated earlier in 2008, most of the periphery countries would have benefited from lower interest rate and a shorter austerity program. The OMT program is subject to three main limitations (De Grauwe, 2013). Primarily, the OMT does not buy government bonds of maturity more than 3 years. This is likely to increase the liquidity risk of the countries, as they are more likely to issue bonds of short. 政治大 to the ESM. Countries applying for OMT are required to apply for the ESM first. At the 立 maturity that they would have difficulty to repay. Further, the OMT program is contingent. ‧ 國. 學. same time the ESM decision is subject to veto of Germany and others countries in the EU. Since Germany strongly opposed the OMT program, it might be difficult for debtor. ‧. countries to pass the ESM evaluation allowing them to be eligible for the OMT. The veto. sit. y. Nat. rule slowed down the decision-making during crisis. It has to be replaced by a majority-. io. al. er. voting rule. Lastly, the ESM itself commits the countries to austerity program, which might. n. worsen the economic recession.. Ch. i n U. v. eann Empirical Part 2: The episode of the debt crisis: g c h i study I.. Story in pictures: the expectation that monetary unions are balance of payment crisis free has not been meet. One of the main goals of the creation of Euro was to promote financial integration within the area. Investors from core Eurozone countries could now move capital to periphery Eurozone countries that provide high rates of return as compared to the core and without any exchange rate cost (Svrtinov, Trajkovska, & Temjanovski, 2015). The existing exchange rates among countries were thought to be non-equilibrium exchange rate and 41 | P a g e.