Euro and the Monetary Policy of the European Central Bank - Book Report/Review Example

Introduction of the Euro and the Monetary Policy of the European Central Bank Introduction This article reviews and analyzes Shigeyuki Hamori’s and Naoko Hamori’s book, “Introduction of the Euro and the Monetary Policy of the European Central Bank”. Shigeyuki Hamori is a professor and lecturer at the Japan’s Kobe University Graduate School, Faculty of Economics. Naoko Hamori on the other hand is a lecturer at the University of Marketing and Distribution Sciences in Japan. The method used by the authors in the book is analyzing the European Central Bank’s monetary policy. This has been done by using the latest econometric methods. The method used by this essay to review the book is a chapter by chapter analysis whereby each chapter of the book is discussed in detail, giving a strong and insightful summary and analysis. The purpose of this book review is to evaluate the substantial contribution made by the book towards understanding the importance of the Euro. The thesis of this book review is to find out the points of view and solutions given by the authors concerning the importance of the Euro area and give an international perspective about the future of the Euro. This essay discusses the Euro area, explaining the reasons why the Euro is an important and unique currency. This review also analyzes the monetary policy of the European Central Bank so as to comprehend the significance of the Euro area. The contents of this book have been clearly presented in nine (9) logical chapters, namely: History of the EU Monetary Union; Empirical Analysis of the Money Demand Function in the Euro Area; Monetary Policy Rule of the European Central Bank; Empirical Analysis of the Term Structure of Interest Rates in the Presence of Cross-Section Dependence; Are Budget Deficits Sustainable in the Euro Area?; Yield Spread and Output Growth in the Euro Area; International Capital Flows and the Feldstein-Horioka Paradox; Nominal and Real Exchange Rate Fluctuations: Euro, US Dollar, and Japanese Yen; and Euro Area Enlargement. The information in these chapters has been well researched and is suitable for non-experts interested in the European Central Bank and the Euro area, advanced graduate and undergraduate students in finance and economics and economists in general. Chapter one: History of the EU Monetary Union The first chapter of the book comes right after the preface and table of contents. It is contained on page 1 to 30. This chapter is aimed at analyzing, outlining and discussing the developments that led to the establishment and realization of the European Monetary Union. This chapter begins by giving the history of the EU monetary union. About a decade ago, the euro was introduced in the 11 states of the European Union (EU) as their single currency. These states are Spain, Portugal, Netherlands, Luxembourg, Italy, Ireland, Germany, France, Finland, Belgium and Austria. The monetary policy of all these states was unified under the European Central Bank (ECB). This has been the case since January 1999. This chapter is insightful because it brings to the attention of the reader the fact that the European Central Bank’s policy management has been able to succeed. This has been despite the many challenges that the policy has been faced with. This chapter also points out that many of the 11 states of the European Union viewed the monetary policy with a lot of caution. Caution was necessary since the policy covered 11 states. However, after the success of the monetary policy, the euro has been able to establish its strong status as a renowned and international currency. The euro is currently second to the US dollar in terms of worldwide status (Hamori and Hamori 1). The establishment of the international status of the euro saw more and more countries join the monetary union. This chapter reveals that the union was officially referred to as the Economic and Monetary Union (EMU). The states that joined this union included Greece (2001), Slovenia (2007), Malta and Cyprus (2008) and Slovakia (2009). The addition of these countries made the number of member states to grow from 11 to 16 because of the success of the euro (Hamori and Hamori 1). In this first chapter, the authors attempt to categorically consider and outline the different types of development that led the European Union to realize the efforts of the Economic and Monetary Union in strengthening the euro. This chapter gives a brief history of the EMU so that readers can understand how countries have been coming together over the years to strengthen the euro. The brief history dates back to 1952, giving a list of events that explains the happenings of the monetary union up to 2009 (Hamori and Hamori 2). It is important to note that initially, in the 1960s, the membership of the economic union was referred to as the European Economic Community (EEC). It initially comprised of six member states, namely: Belgium, France, Germany, Italy, Luxembourg, and the Netherlands. According to the authors, the need to have a monetary union in the area pushed these countries to work together and get others to join the monetary union for various reasons. Some of these regions included the fact that EU countries would freely engage in the intra-global integration of markets. This would see the free movement of services, goods and people so as to establish a highly competitive and united economic zone that would effectively compete with other economically powerful regions such as Japan and USA (Hamori and Hamori 3). The various experiments outlined in this chapter that were aimed at achieving monetary union are very insightful because they highlight the financial crisis that took place in 1969. Various reports such as the Werner report are highlighted in this chapter, giving their contents and purposes. This chapter also highlights the formation and importance of the European Monetary System (EMS), highlighting the process followed through to its creation (Hamori and Hamori 5). This first chapter generally attempts to give a summary of the factors that led to the realization of the EMU in the European Union. Readers are informed about the history of the economic integration in the EU. It becomes apparent this integration took a very long time to materialize, approximately 30 years (Hamori and Hamori 29). This delay can be attributed to the changes that were taking place in the international economy and the international currency system. These changes can also be attributed to financial conditions of that period. The small steps and advances of the EU towards the realization of the monetary union have been well documented in this chapter. Such steps included the snake (European Economic Union) and then the EMS. The authors have done a great job at depicting the tolerance and flexibility that led to the realization of the EMU. The authors have also done a great job at depicting how the leadership of many of the EU states such as France and Germany improved as the countries were able to overcome their differences and work together. The chapter ends by showing how the member states were able to enjoy the success of the euro area and the monetary unions that they had established (Hamori and Hamori 30). In this chapter, the authors have been able to bring readers to speed with the step by step establishment of the monetary union among the European Union states. Chapter two: Empirical Analysis of the Money Demand Function in the Euro Area Chapter two is contained on page 31 to 58. This chapter is concerned with the empirical analysis of the money demand function in the euro area. The authors have been able to empirically analyze how the demand function of money plays in the euro area and have been able to report their findings in this second chapter. The chapter begins by noting that the euro has been a single currency for more than 11 states in the European Union since January 1999. This milestone marked the beginning of a monetary policy that unified more than 11 EU countries. According to Hamori and Hamori (31), the European Central Bank aimed to achieve its goals by adopting a two-pillar strategy. The authors point out that the first pillar was aimed at setting and announcing a reference value for the growth experienced yearly in the M3 money supply. The initial value set was 4.5%, assuming that economic growth would be at a rate of between 2 and 2.5%. This value also assumed that the velocity at which the M3 circulation would drop would be around 0.5 to 1.0% annually. The last assumption of the first pillar was that the consumer prices harmonized index would not show inflation rates of more than 2% for the whole euro area in general (Hamori and Hamori 32). According to the author’s, the second pillar of the two-pillar strategy was aimed at assessing the risk of price stability. According to the ECB, the stability of prices would be defined numerically since the consumer prices harmonized index were not more than 2% for the entire euro area during a medium term period (Hamori and Hamori 31). It is important to note the intentions of the ECB as it adopted the two-pillar strategy. From an analytical point of view, it is correct to conclude that the ECB was able to manage the monetary policy and curb the high inflation rate. The goal of this was to bring income creation and sustainable employment over the long term (Hamori and Hamori 31). The ECB also based its strategy on the fact that the supply of money was one of the most basic factors that would contribute to inflation. Therefore, controlling how money was supplied would be one effective way of ensuring price stability over the long and middle term. Money supply was therefore used as the main indicator (Hamori and Hamori 32). At this point, the authors note that the ECB was committed to examining other financial and economic indicators so as to assess the risks to price stability and the outlook for the trends of prices (Hamori and Hamori 32). The chapter also reveals how the ECB revised its two-pillar strategy in May 2003 for the monetary policy. The revisions of the strategy were focused on keeping inflation levels minimal and money supply regulation. The authors point out how these revisions were opposed by critics who thought the revisions were not good for the euro. Despite the criticism, the ECB has upheld the policy since its formation. This is because the ECB still believe that the money supply trends can be used as a leading indicator of the levels of inflation (Hamori and Hamori 32). This chapter has critically analyzed the money demand function in the euro area. The analysis has been done using empirical tabulation of data, with focus on demand for M1, M2 and M3. The authors have used aggregate data analysis and panel data analysis to explain the money demand function in the euro area (Hamori and Hamori 32). The concluding remarks given by the authors on page 57 enable the readers to clearly understand and have an overview of how the money demand function plays in the euro area. The empirical results of the authors support how money demand for M1, M2 and M3 is co-integrated (Hamori and Hamori 48). In the aggregate data analysis, the results lead to the conclusion that the estimated demand elasticity in respect to output is greater in M1 than it is in M2 and M3. The results also suggest that the estimated interest rate coefficient absolute value is greater for M1 than it is in M2 and M3. This leads to the analytical conclusion that when managing the monetary policy, the European Central Bank should contemplate using the M1 or M2 as the reference value as opposed to the use of M3 (Hamori and Hamori 48). It can be generally concluded that this chapter has used panel and aggregate data to analyze the stability of 11 European Union countries. A keen look at the findings of the authors reveals that at first, the money demand function appears to be stable with the M3. This fact has been used to support the monetary policy of the ECB’s focus on the M3 money supply (Hamori and Hamori 51). The authors have also made it possible for readers to realize the stability of the money demand function with respect to M1 and M2, not only M3. Depending on how the conditions change over time, the findings of these studies are a clear indication that the European Central Bank should also focus on the adoption of M1 and M2 as reference values (Hamori and Hamori 49). Chapter three: Monetary Policy Rule of the European Central Bank This chapter runs from page 59 to 70. The main focus of this chapter is the monetary policy rule that is used by the European Central Bank. The introduction makes the readers aware of the fact that the European Central Bank is the guardian of the euro. The EU states that are in a monetary union have all entrusted the European Central Bank to be their chief custodian and guardian of the euro. In order to be effectively capable of carrying out its mandate, the ECB must be guided by rules and policies that direct its day to day action for the overall good of the euro area (Hamori and Hamori 59). In this chapter, the Taylor-rule that was used by the European Central Bank has been clearly outlined. The weaknesses and strengths of the Taylor rule have been discussed so as to give readers an understanding of its benefits and shortcomings. The chapter has empirically analyzed the Taylor-type policy response, explaining why the ECB chose it as one of its core functions (Hamori and Hamori 59). The authors have used monthly data collected from the financial markets from January 1999 to December 2007. This therefore means that the information contained in this chapter is highly reliable and has been correctly used to come up with the conclusions and inferences made by the authors in this chapter (Hamori and Hamori 60). The authors have categorically discussed the important role played by long term interest rates in the policy reaction function. This means that long term interest rates greatly influence the policies and the reactions of the European Central Bank. The ECB focuses in the trends of the long term interest rates in determining some of its greatest monetary policies (Hamori and Hamori 62). The monetary policies created by the ECB are sometimes a reflection of the long term interest rates (Hamori and Hamori 63). In this chapter, the authors have made reference to Kristen who has pointed out that the long term interest rate may also affect and influence how the public perceives long-run inflation (Hamori and Hamori 64). This means that since long term interest rates are known to play a vital role in the policy reaction function, the long term interest rates may serve as a proxy on how the public perceives long-run inflation. The European Central Bank should therefore focus on regulating the long term interest rates as this have a role to play in the rate of long-run inflation (Hamori and Hamori 66). This data used in this chapter, collected from January 1999 to December 2007, has been empirically analyzed so as to explain the results of the authors. The empirical results discussed in this chapter are the simple Taylor rule and the role of long term interest rate, especially on long-run inflation (Hamori and Hamori 67). The concluding remarks given by the authors explain the role of the Taylor rule and the role of long term interest rate. These are the two major monetary policies of the European Central Bank that the chapter has focused on (Hamori and Hamori 69). Chapter four: Empirical Analysis of the Term Structure of Interest Rates in the Presence of Cross-Section Dependence Beginning from page 71 to page 86, this chapter has empirically analyzed the term ‘structure of interest rates’. The analysis has used panel data collected within the euro area. The introduction makes readers aware that the chapter has specifically focused on cross section dependence of the EU states that have entered into the monetary union. Various models have been used to conduct the analysis and the results depict that the hypothesis expected is compatible with both long term and short term interest rate fluctuations within the euro area. This is especially so if the cross section dependence is appropriately considered (Hamori and Hamori 71). The chapter uses empirical data analysis to ascertain the claims made by the authors concerning the term structure of interest rates in the presence of cross-section dependence. The panel data has been analyzed using econometric methods so as to reach the conclusions made by the author. The chapter has presented the empirical results with cross section independence and empirical results with cross section dependence. This means that the analysis was done using two different scenarios. The first scenario involved the assumption that the members of the EU states were independent and did not have a monetary union. The second scenario assumed that the members of the EU states depended on each other on monetary issues and policies (Hamori and Hamori 72). The results presented in this chapter may be suitable in providing evidence of how the fiscal rules effectively function within the euro area. This is especially true considering the fact that the EU states depend on each other to strengthen the euro. How the euro fairs may therefore be determined by the financial climate of the euro area (Hamori and Hamori 75). Chapter five: Are Budget Deficits Sustainable in the Euro Area? This chapter is begins on page 87 and ends on page 97. It is a fairly short chapter that seeks to explain whether budget deficits are sustainable in the euro area. The issue of budget sustainability is empirically analyzed in this chapter. Each of the 11 European Union countries is examined and analyzed in great detail so as to come up with the general results (Hamori and Hamori 87). The analysis involved a thorough examination of whether the fiscal performance of the euro area between the period of 1991 and 2005 was sustainable. Each country was examined individually and an analysis of how each state contributes to the strengthening of the euro in the euro area was done (Hamori and Hamori 88). Through the empirical examinations done in this chapter, it was discovered that between the periods of 1997 to 2005, the fiscal performance of the euro was very sustainable (Hamori and Hamori 90). These discoveries supported the notion that the fiscal discipline rules effectively served their purpose. This also led to the conclusion that the fiscal deficits of each individual country were steadily decreasing. In such a monetary union, the fiscal deficits of each individual country would affect the whole union. It is therefore advisable that each country works on decreasing its fiscal deficit so as to promote the entire euro area. The countries cannot function effectively in isolation because they are in a monetary union. The contribution of each country is therefore crucial (Hamori and Hamori 93). The chapter has focused on models, data, and empirical results, and given some concluding remarks by the authors to explain whether budget deficits are sustainable in the euro area (Hamori and Hamori 97). Chapter six: Yield Spread and Output Growth in the Euro Area This chapter is found on page 99 to 113 of the book. It focuses on how yield spread has been in the euro area and how output growth has been doing. The authors have used the same system like in most of the other chapters. They have given an introductory paragraph that seeks to acquaint the readers with the yield spread and output growth of the euro area (Hamori and Hamori 99). Models of doing the empirical analysis have also been clearly laid out. The authors have used both aggregate and panel data to analyze the output growth and the yield spread of the euro area and come up with the empirical results (Hamori and Hamori 100). The relationship between future output growth rate and the yield spread of the euro area has been empirically analyzed and discussed using both panel and aggregate data collected from the euro area (Hamori and Hamori 110). According to the empirical results shown in the chapter, it is important to note that the yield spread of the US is very crucial in giving an explanation of how the future output growth of the 11 European Union countries can be analyzed (Hamori and Hamori 113). Chapter seven: International Capital Flows and the Feldstein–Horioka Paradox This chapter is found on page 115 to 123, being one of the shortest chapters, it has effectively managed to introduce readers to the international capital flows and the Feldstein-Horioka paradox (Hamori and Hamori 115). The authors have used panel data to analyze the stability of the investment saving rate of the euro area. It can be correctly concluded that in most samples, the relationship between investment and saving tends to be rejected. This is a clear indication that as the euro area integrates more capital markets, the relationship between investments and saving tends to disappear (Hamori and Hamori 123). Chapter eight: Nominal and Real Exchange Rate Fluctuations: Euro, US Dollar, and Japanese Yen In this chapter, the authors have used an approach known as the long-run structural vector auto-regression (VAR) to analyze the sources of nominal and real fluctuations of the effective exchange rate. This has been done in comparison with the Japanese yen and the US dollar. The authors identified the two types of macroeconomic shock that were used to determine what really drives the movements in the real exchange rates (Hamori and Hamori 125). These two types of macroeconomic shocks were nominal and real. After a thorough analysis, the evidence presented used two systems. These were the bivariate and trivariate systems. Empirical techniques were applied to each system to come up with the empirical results (Hamori and Hamori 128). According to the data in the chapter, there is a clear indication that nominal and real effective exchange rate fluctuations are dominantly explained by real shocks. It is also evident that the movements in nominal and real effective exchange rates stronger in Japan and the euro area compared to the United States (Hamori and Hamori 129). Chapter 9: Euro Area Enlargement This is the final chapter of the book and it is contained in page 143 to 184. The chapter is focused on how the euro area can be enlarged and how it is enlarging. The major issues discussed in this chapter include the background, key issues, current issues and future prospects for the enlargement of the euro area (Hamori and Hamori 144). The authors have analyzed both group and individual countries so as to effectively discuss the characteristics and issues they face. The countries examined include the EU member states such as UK, Denmark, Sweden and Greek. EMU participants were also examined and they included countries such as Slovakia, Malta, Cyprus and Slovenia. The chapter examined other accession countries, those that are not ERM II participants and those that are ERM II participants (Hamori and Hamori 145). Conclusion In summary, the authors have depicted the euro area as an extremely important and unique currency area. This is because the euro area is the single largest currency area that has ever been created in any industrialized region. The euro area is also important because it was established by sovereign states that have been working as peers. The authors have noted that despite the challenges faced by these countries, they have been able to autonomously and peacefully create a single currency area that has been that is one of the most successful. This book is very invaluable since it marks the 10th anniversary since the creation of the European Central Bank and the Euro. The authors have successfully analyzed the monetary policy of European Central Bank. Work cited Shigeyuki Hamori and Naoko Hamori. Introduction of the Euro and the Monetary Policy of the European Central Bank. World Scientific Publishing Co Pte Ltd: Singapore, 2010. Print. Read More