Inflationary Pressure and Labor
Conflict
 Inflation in the 1960s jeopardized the corporatist
wage structure of the postwar period
 In the late 1960s work stoppages began to occur
where workers demanded higher wages
Factors Leading to Friction in the
Labor Market
1) Decline of agricultural workers to less than 15% of
employment continent-wide

Elastic supplies of labor in underemployed agricultural
workers no longer exists
2) Unemployment as a whole declined leaving the threat
of unemployment as a restraint on wage demands as no
longer a viable option
3)Wage and price inflation did not subside even when
unemployment rose, which indicated there were other
factors at work


Young no longer remembered what it was like to be
unemployed
People were no longer willing to sacrifice themselves for
postwar reconstruction and preferred immediate
gratification instead
Factors Leading to Friction in the
Labor Market (cont.)
4) The Soviet threat was seen as less immediate,
removing one immediate incentive for labor and
capital to pull together
5) Another important event in this time period was
the weakening and final breakdown of the Bretton
Woods system in the 1970s


Exchange rates were fixed and then inflation became
temporary, with its breakdown, this was no longer the
case
Unions started to fear inflation and wanted wage
increases
Friction in the Labor Market
(cont.)
 Wages started to grow but production slowed
 Profits began to fall right before the 1973-1974 oil
price shock
 Governments tried to contain inflation with
controls (such as a statutory freeze on wages and
prices)
 These tactics were not very successful
Contradictions of Corporatism
1973 OPEC Oil Crisis and the Rise
of Oil Prices
Contradictions of Corporatism
 Countries began to promise workers more benefits in
exchange for wage restraint
 But, financing these benefits was very expensive
 Where the institutions of corporatism were most
advanced, their reinforcement limited the rise in labor
costs and the rate of unemployment
 After the wage explosion of 1974-75, wage increase
slowed
 Inflation wasgetting worse and making things difficult
to handle
 Keynesian demand stimulus was used to keep
unemployment levels down
 However, the golden years of Europe were over
Contradictions of Corporatism
(cont.)
 Recession came about
 The 2nd OPEC oil-price shock at the end of the 1970s
made things even worse
 Unions no longer wanted to practice wage
constraint
 Public employment (and hiring) had gone up for
the last recession and was no longer a viable option
to use
 Social corporatism began to crumble and by the
mid-eighties it was in retreat
Retreat Into Regional Integration
 European governments tried to create economic
stability with the process of European integration
 UK, Ireland, and Denmark joined the EEC
 A new system needed to be put in place to replace the
now defunct Bretton Woods system
 European countries did not want uncontrolled
exchange rates
 Europe's response was “The Snake” - December 1971
 Participating countries held their exchange rates within
narrow margins and established financing facilities to
extend credits to one another

However, they still lacked a convergence in their monetary and
fiscal policies
Retreat Into Regional Integration
(cont.)
 Countries with inflationary policies were driven
from the Snake
 The UK was the first to withdraw in June 1972
 Denmark withdrew one week later but returned in
October
 Italy withdrew in 1973
 France was forced to float in January 1974
 Sweden withdrew in 1977
 Norway withdrew in 1978
The Snake
Retreat Into Regional Integration
(cont.)
 France and Germany wanted political and monetary
integration for exchange rate and inflation stability
 A new system came about in 1979 – European Monetary
System
 A better version of the Snake
 Participants had to hold their currencies within 2.25%
to fluctuation bands, but countries were allowed to
revalue and devalue
 8 out of the 9 EC members joined the EMS at the
beginning (except UK)
 No one was forced to withdraw in the 1980s although there
were realignments
 Yet the poor coordination of macroeconomic policies
strained the EMS
Rising Unemployment and the
Integrationist Approach
 The 1980s were a decade of dissapointment for
growth and productivity for Europe
 Unemployment was still high
 Causes of the problem
1) Inadequately flexible wages
2)Overly rigid work rules
3)Excessive labor costs
Rising Unemployment and the
Integrationist Approach (cont.)
 Another solution was looked at in integration – deeper
integration adding free movement of capital and labor
to the existing customs union
●
●
●
The aim was to be like the US so European producers could
exploit economies of scale and compete internationally
This came with the Single European Act (SEA) in 1986 –
signatories agreed on the creation of a single market free of
internal barriers to trade
The Maastrict Treaty (early 1990s) was the next step

There was a commitment to move to a monetary union (a single
monetary policy, a European Central Bank and a single currency)
Rising Unemployment and the
Integrationist Approach (cont.)
 Removing capital controls was important for monetary
integration
 The elimination of controls made the EMS more fragile
because countries were now faced with destabilizing
capital flows
 If investors thought a country was going to realign its
exchange rate, there was a massive outflow of funds

There were no more realignments
 Fixed Exchange Rates, International Capital Mobility
and Monetary Independence are mutually incompatible
 Europe had to choose between fixed exchange rates and
independent monetary policies
 Common currency was the best option
Rising Unemployment and the
Integrationist Approach (cont.)
 For countries other than Germany which had to
follow the Bundesbank's policies, now they could
have more say in their monetary destinies
 They had no representatives on the Bundesbank but
would have representatives on the ECB
 An alternative to this was to face FX-volatility
Rising Unemployment and the
Integrationist Approach (cont.)
 Guided by the Delors Report, a three-step transition
of the Maastricht Treaty to a monetary union:
1) Stage I (1990-93): countries bring their national
economic policies more closely in line, remove
remaining capital controls and butress the
independence of their central banks
2)Stage II (1994-1998): further convergence of policies
and by creation of a transitional entity, the European
Monetary Institute, to plan the move to a monetary
union
3)Stage III (starting in 1999): monetary union itself
European Economic and
Monetary Union
 Stage III:
 Austria, Belgium, Finland, France, Germany, Ireland, Italy,







Luxembourg, Netherlands, Portugal and Spain join the EMU
in 1999
Greece joins in 2001
Slovenia joins in 2007
Cyprus and Malta join in 2008
Slovakia joins in 2009
Denmark, Sweden and United Kingdom refused to join
Estonia joined in 2011
Potential new members (no exact date can be given due to the
current Eurozone crisis):





Lithuania (previous target 2010)
Poland, Latvia and Czech Republic (previous target 2012)
Hungary (previous target 2013)
Romania (2014)
Bulgaria (2015)
The Crucible of Integration
 Collapse of centrally-planned system had the biggest
impact on Germany where there was immigration from
the East
 Germany proposed reunification of both Germanys – the
Soviet Union was not in a position to object
 Eastern Germany came under Western Germany's wing
 Living standards were lower in the East, there was outdated
infrastructure and equipment
 In 1991 the new lander accounted for 20% of Germany's
labor force but less than 7% of its GDP
 There was still a strong incentive to migrate west
 The East was also cheap labor threatening unions
Germany's Integration
 The Bonn Government responded by giving the same
benefits and wages to the East that the West had
 This helped to lower migration to West and bring up their
productivity
 These transfers of money gave Germany deficits
 Germans did not want to pay higher taxes and this led to
higher interest rates since the Bundesbank did not
intervene
 Interest rates were hitched due to the pegged exchange rates
of the EMS – this affected all of Europe
 Unemployment in the whole continent rose
 This turned into a crisis that disrupted the progress of
Europe's integration
Integration in Distress...
 Denmark rejected the Maastricht Treaty in a
referandum in June of 1992
 This raised the possibility that a monetary union might not
happen
 Speculators anticipated that the Bank of England and
the Bank of Italy would respond by cutting their interest
rates and allow their currencies to depreciate (could not
be done before because of the prospect of the monetary
union)
 Speculators pounced on their currencies
 This drove Italy and England out of the EMS
 Their currencies depreciated by 30%
Integration in Distress...
 Spain, Ireland and Portugal were also forced to
devalue several times
 By 1993 the crisis affected France whose currency
was one of the center currencies of the EMS
 The EMS bands were finally widened from 2.25% to
15%
 This allowed speculators to retire to the sidelines
and for European financial markets to settle down
 Governments again began pursuing the Maastricht
Criteria
Integration in Distress...
 Unemployment though was still high
 Corporatism was in decline and this caused high
wages and non-wage costs
 Europe needed to cut hiring and firing costs
 Within all of this the Maastricht Criteria began to
mean unemployment for a lot of European
countries
The Collapse of Central Planning
 Centrally planned economies broke down completely at
the end of the 1980s
 Eastern Europe just could not keep up with the new
technology and production of the West
 In order to keep going Eastern Europe had borrowed a
lot of money from the West and the US in the 1970s
(about $70 billion by the end of the 1970s)
 This finally led to a debt crisis in 1981-82
 To pay of its debts and keep its economies going, the
Eastern European countries began to let market
principles creep in
 In the end economic freedom and political repression
proved incompatible – Central planning collapsed
Difficulties of Transition
 Eastern Europe had a way difficult transition to the
market
 Between 1990-1992 output and employment
plummetted
Difficulties of Transition
Difficulties of Transition
 These countries needed to reallocate resources from
the production of heavy machinery to consumer
goods – they needed to go from manufacturing to
services
 Obviously this would bring down output
 Western Europe had the same challenge after WWII
 The difference was the Marshall Plan
 There was no Marshall Plan for Eastern Europe
 Liberalization needed to take place to give managers
incentive to make profits and avoid losses
Difficulties of Transition
Difficulties of Transition
 Radical transition happened
 The front runners in the transition were Hungary,
Poland and Slovenia
Europe in the
●
st
21
Century
In economic sense Europe in 1948 and Europe
today look very different
Differences
1948 Europe
Europe Today
High wage economy producing technologically and
Economy based on heavy industry, heavy inputsof fixed
organizationally – sophisticated goods and services
investment and backlog of unexploited technology
using products and processes developed at home
Economies divided into closed national economies and
driven by an unbridgeable east-west gap
Establishing an integrated market
East-bloc and Soviet threat
Collapse of East-bloc, no longer a Soviet threat,
formerly communist nations seeking admission to
the EU
Governments pursued strategies that sought to
manipulate markets and relied on the close
collaboration of union federations and employers
associations
Leverage of governments and social partners
limited (liberalization of markets)
Links between Europe of
Yesterday and Today...
1) Shift to intensive growth
2)Governments increased spending and hiring to
keep labor happy now leading to massive
unemployment and higher taxes
3)Regional integration
4)Major financial crisis
Based on Benjamin Cohen’s article “Monetary
Governance in a World of Regional Currencies”
Deterritorialization of Money
 Circulation of national currencies no longer
coincides with territorial boundaries of nationstates
 Dollar and Euro used widely outside their origin
competing directly with local currency for both
transactions and investment purposes
 Called currency substitution (effect of globalization)
 Before there was a monopoly of currency now there
is an oligopoly
 Another alternative has been to replace national
currency with a regional money
Currency Regionalization
 Currency Regionalization occurs when two or more
states formally share a single money
1. Currency Unification: Countries merge their separate
currencies into a new joint money (ex: EU and the
Euro) – ALLIANCE
2.Dollarization: Any single country can unilaterally or by
agreement replace its own currency with an already
existing other currency (ex: Monaco, Panama, Ecuador,
El Salvador) - FOLLOWERSHIP
Darwinian Struggle of Currencies
 The number of currencies in the world is declining
 Although not all national currencies will dissapear
due to national pride
1. Currency Unification: Monetary Sovereignty is pooled
(ex. ECB)
2.Dollarization: Monetary Sovereignty is surrendered
(ex. Countries following the US $)
Currency Choices
1) Traditional Sovereignty
2)Monetary Alliance
3)Formal Subordination
 Economic globalization is leading nations to
reconsider traditional monetary sovereignty
Currency Regionalization
 50 years ago, national monetary systems were
generally insular and strictly controlled
 In the 1950s barriers separating local currencies began
gradually to dissolve
 This was partly due to increased trade

Facilitated increased flow of funds between states
 It was also partly due to increased competition,
technology and innovation
 Currency substitution began to take hold
Currency Regionalization
 Capital mobility – another effect of globalization
 Led to the integration of financial markets
 Money is now being used in many different ways:
 Store of value
 Investment medium
 Medium of exchange
Currency Regionalization
 Foreign currency notes in the mid-1990s accounted
for 20% or more of the local money stock in as many
as three dozen (~36) nations inhabited by one-third of
the world population
 25% - one-third of the world’s money supply is now
located outside its country of issue
 Currency substitution is most popular in:
 Latin America, Middle East, Former Soviet Union states –
favor the US $
 Balkans, East-Central Europe – favored the DM and now
the €
Currency Substitution
 By the mid 1990s there were at least 18 countries that
had 30% of their money supply in another currency
 Most extreme cases (over 50%):
 Azerbaijan, Bolivia, Croatia, Nicaragua, Peru and
Uruguay
 Another 39 countries were approaching the 30% level
indicating “moderate” penetration
Currency Substitution
 Some economists wonder how this will affect FX rates
 Traditionally FX:
 Fixed Exchange Rates
 Single Currency
Irrevocable (Currency Board)
 Basket of Currencies
Target Zone
 Flexible Exchange Rates
 Managed
 Left to the market of supply and demand
●
●
 Recently FX:
 Contingent Rules
 “Corner Solutions”
 Free Floating
 Monetary Union
Currency Regionalization
 More is at stake than FX rates
 The real question is of national monetary sovereignty
 Economic actors are no longer restricted to a single
currency and this has led to a sort of currency
competition
Currency Regionalization

5 main benefits of a strictly territorial currency:
1.
2.
3.
4.
5.
Potential reduction of domestic transactions costs to
promote economic growth
A potent political symbol to promote a sense of national
identity
A powerful source of revenue (seigniorage) to underwrite
public expenditures
A possible instrument to manage the macro-economic
performance of the economy
A practical means to insulate the nation from foreign
influence or constraint
Seigniorage
Seigniorage, also spelled seignorage or
seigneurage, is the net revenue derived from the
issuing of currency. It arises from the difference
between the face value of a coin or bank note and
the cost of producing, distributing and eventually
retiring it from circulation. Seigniorage is an
important source of revenue for some national
banks.
Currency Regionalization
 All of these are eroded when a government is no
longer able to exert control over the use of its money
 So policymakers are forced to compete for the
allegiance of markets agents to sustain and cultivate
market share for their own brand of currency
Currency Regionalization

Four Strategies are Available:

1.
Market Leadership


2.
Considerations:

Policy is defensive (preserve market share)

Policy is aggressive (promote share)

Policy is unilateral

Policy is collective
Aggressive, unilateralist policy intended to maximize the use of
national money
Predatory price leadership
Market Preservation

Status-quo policy intended to defend a previously acquired
market position for the home country
Four Strategies (cont.)
3.
Market Alliance
●
4.
Collusive policy of sharing monetary sovereignty in a monetary
union of some kind
Market Followership
●
●
Policy of subordinating monetary sovereignty to a stronger
foreign currency via a currency board or full dollarization
Passive price followership

Strategy of Market Leadership only available to countries
with the most widely circulated currencies ($, €, Yen, ...)

For other currencies only the other three choices remain
Currency Regionalization
 The question is: What constraints on national policy are
states willing to accept?
 Market Preservation: Keep their traditional monetary
sovereignty

Many states still choose this route regardless of how uncompetitive
their currency may be
 Monetary Alliance: Join a union and delegate some of that
authority
 Market Followership: Give up all monetary sovereignty
 “Produce their own money or buy it from someone else”
Currency Regionalization
 Monetary Sovereignty can be defended with tactics of:
 Persuasion: trying to sustain demand for a currency by
supporting its reputation
 Coercion: applying formal regulatory powers of the state
to avert any significant shift by users to a more popular
foreign money

Ex: laws that dictate what money creditors can accept for debt,
limits on foreign currency deposits, exchange restrictions
Defending Monetary Sovereignty
 These tactics can become expensive as currency
competition accelerates
 May lead to less growth and more unemployment
 Due to this, many countries have begun to consider the
solution of a monetary union either in the form of:
 Dollarization: (ex. Latin America)

Not difficult to imagine two giant monetary blocs (US and EU and
maybe possibly Japan as a third bloc) due to increased dollarization
 Currency Unification (ex. EU)
 Much will depend on the policies of the market leaders
and will alter the costs and benefits of followership
Benefits of Monetary Leadership
 Additional opportunities for Seigniorage
 Enhanced degree of macroeconomic flexibility
 May yield dividends in terms of power and prestige
 This could lead US-EU-Japan to offer incentives to
potential dollarizers
 Risks of Monetary Leadership:
 Policy constraints to consider the needs of followers
Monetary Decisions
 Another option is to join a currency union
 Examples are the EMU, CFA Franc Zone in Africa, Eastern
Caribbean Currency Union (ECCU) in the Caribbean
 EMU is a test of pooling rather than surrendering
monetary sovereignty
The Rise of Currencies...
 Presently there are more than 170 central banks in the
world
 100 years ago there were fewer than 20
 If there are more than 100 currencies could this really
lead to stability?
 Some economists argue that regionalization of
currencies is a no-brainer
Policy Considerations
 Alliance or Followership?
 Will depend on:
 Issuing of Currency
 Management of Decisions
Currency Issue
 Highest degree of currency regionalization is when a
single money is used by all participating countries
 This is the way dollarization works
 Ex. Lichtenstein and Micronesia
 EU and ECCU are other examples
Fully Dollarized Countries
US $
US Virgin Islands, Caribbean
Netherlands, El Salvador, Marshall
Islands, Micronesia, Palau, Turks and
Caicos
Euro €
Andorra, Kosovo, Montenegro, San Marino,
Vatican City, Monaco
New Zealand $
Niue, Pitcairn Islands, Tokelau
Australia $
Nauru
South African Rand
Swaziland, Lesotho, Namibia
Others
Armenian Dram – Nagorno Karabakh;
Russian Ruble – South Ossetia and
Abkhazia; Indian Rupee – Bhutan and
Nepal; Swiss Franc – Lictenstein; Israeli
shekel – Palestenian territories; Turkish lira
– TRNC;
Currency Issue (cont.)
 Parallel circulation of two or more monies (still
dollarization)
 Ex. Panama uses US $ and locally issued coins
(Panamanian balboas)
 Near-dollarized countries – foreign currency
dominates domestic money supply but falls short of
absolute monopoly
 Lower degree of dollarization than full dollarization
Near-Dollarized Countries
Country
Currency Used
Since
Local Currency
Ecuador
US$
2000
Sucre
El Salvador
US$
2001
Colon
Kiribati
Australian $
1943
Own coins
Panama
US$
1904
Balboa
Tuvalu
Australian $
1892
Tuvaluan dollar
East Timor
US$
Own coins
Cook Islands
New Zealand $
Own coins
Currency Issue (cont.)
 Even lower degree of dollarization – Currency Board
 Home money accounts for a large part of domestic
money supply however its issue is firmly tied to the
availability of a designated foreign currency – referred
to as “anchor currency”
 The exchange rate is fixed between the two countries
 Both currencies circulate as legal tender
 Any increase in local money supply should be backed
by an increase in the reserve holdings of the anchor
currency
 Ex. Bulgaria, Lithuania (Argentina was of this group
until the collapse of 2002)
Currency Board
Country
Anchor Currency
Since
Local Currency
Bermuda
US$
Bosnia and
Herzegovina
Euro (formerly DM)
1998
Bosnian marka
Brunei Darussalam
Singapore dollar
1967
Brunei dollar
Bulgaria
Euro (formerly DM)
1997
Lev
Cape Verde
Euro
1999
escudo
Cayman Islands
US$
Comoros Islands
Euro (formerly FF)
1979
Comorian franc
Denmark
Euro
1999
Danish Kroner
Djibouti
US$
1949
Djibouti franc
Hong Kong
US$
1983
Hong Kong dollar
Latvia
Euro
2005
Lat
Lithuania
Euro (formerly US$)
2002
Litas
Macao
Hong Kong $
Morocco
Euro
1999
Dirham
Sao Tome e Principe
Euro
2010
Dobra
Currency Issue (cont.)
 Lowest Degree of Dollarization – Bimonetary
Relationships
 Legal tender status is extended to one or more foreign
monies but without the formal ties of a currency
board
 Local money supply is not dependent on availability
of anchor currency
 Exchange rate is not irrevocably fixed
 Ex. Bhutan, the Bahamas
Bimonetary Relationships
Monetary Alliance
•Parallel circulation of 2
or more currencies is
also consistent with a
monetary alliance