1. The Euro: Considerations

2. The Feldstein Thesis Turning over monetary authority to the ECB removes an important component of macroeconomic policy from individual European governments. Turning over monetary authority to the ECB removes an important component of macroeconomic policy from individual European governments. If a recession comes in Italy (but not in the EU generally), the Italians cannot run deficits (EU rules) and cannot increase the money supply to stimulate the economy. What will happen when a serious recession hits in part of the EU countries? If a recession comes in Italy (but not in the EU generally), the Italians cannot run deficits (EU rules) and cannot increase the money supply to stimulate the economy. What will happen when a serious recession hits in part of the EU countries?

3. The Feldstein Thesis Feldstein thought the EU would unravel. Feldstein thought the EU would unravel. The Maastricht rules. (No excessive deficits, debt or inflation.) The Maastricht rules. (No excessive deficits, debt or inflation.) Krugman thought they made no sense. They’re like hazing to get into a fraternity at some local university. Krugman thought they made no sense. They’re like hazing to get into a fraternity at some local university. Did they have any purpose? Did they have any purpose?

4. The ECB transparency issue. Why doesn’t the ECB publish its minutes? Why doesn’t the ECB publish its minutes? So individual countries can’t get upset when their central bank representative votes in the interest of the community rather than their particular, narrow national interest. So individual countries can’t get upset when their central bank representative votes in the interest of the community rather than their particular, narrow national interest. So is transparency sufficient in the ECB? So is transparency sufficient in the ECB?

5. Chinese And Japanese Purchases of US Bonds (Shifting from the US Dollar to the Euro as a country’s reserve currency) The value of Yuan, Yen, US$ and the Euro

6. What are China’s trade policy objectives? Keep the value of the Yuan low to promote exports. Keep the value of the Yuan low to promote exports. Keep the U.S. export market open. Keep the U.S. export market open. China has 50 million jobs dedicated to its U.S. trade, and rural Chinese continue to pour into manufacturing areas seeking work.

7. How has China kept the Yuan price low? Sell Yuan in foreign currency markets. Sell Yuan in foreign currency markets. Buy dollars. Buy dollars.

8. Dollars become foreign currency reserves. How can you make money on reserve holdings? Purchase U.S. treasury bonds. Purchase U.S. treasury bonds.

9. Why do we sell so many bonds? To finance the war in Iraq, to fund Katrina-related projects, to fund medicare prescription benefits, To finance the war in Iraq, to fund Katrina-related projects, to fund medicare prescription benefits, Etc., Etc., Etc. Etc.

10. In purchasing our bonds, China supports the maintenance of the U.S. trade-finance system. We need the foreign funds to sustain our import deficits. In purchasing our bonds, China supports the maintenance of the U.S. trade-finance system. We need the foreign funds to sustain our import deficits. Why does China want to sustain our system by purchasing treasury bonds? Why does China want to sustain our system by purchasing treasury bonds? The Chinese have around two hundred billion dollars invested in it. They want to retain our export markets. U.S. bond yields, somewhat low by historical standards, are still higher than those of the other major countries. The Chinese have around two hundred billion dollars invested in it. They want to retain our export markets. U.S. bond yields, somewhat low by historical standards, are still higher than those of the other major countries.

11. What happens if China were to sell off their bond holdings? The increase in supply would drive the price down. $96 $92 S1 S2 So the interest rate rises from 4% to 8%.

12. When China unpegged the Yuan, they purchased Euros to support their new market basket pegging. Interest rates rose immediately as bond prices fell (although only a little.) Interest rates rose immediately as bond prices fell (although only a little.) We panicked. China restructuring it’s reserve portfolio? We panicked. China restructuring it’s reserve portfolio?

13. A cutback can do the same job as a selloff in the Treasury bond market! Cutback Selloff Cutback Selloff

14. Japan has been doing the same thing, only they’ve got a lot more bonds! Why do they buy bonds? Why do they buy bonds? They want to sell Yen, so they buy dollars with them in the foreign exchange markets. They want to sell Yen, so they buy dollars with them in the foreign exchange markets. With the huge dollar reserves, they buy U.S. bonds. 3-4% interest is better than just sitting on the dollars. They have c. $740 billion in our bonds and have lost c. $110 billion in value with decline of the dollar. With the huge dollar reserves, they buy U.S. bonds. 3-4% interest is better than just sitting on the dollars. They have c. $740 billion in our bonds and have lost c. $110 billion in value with decline of the dollar.

16. Japan’s Interest in the Dollar To maintain the bond market is to defend the dollar. If the bonds sell big time, the value of the dollar would fall. Even if China stopped buying U.S. securities, Japan's central bank probably would step in and defend the dollar to protect its own huge export trade with the United States. To maintain the bond market is to defend the dollar. If the bonds sell big time, the value of the dollar would fall. Even if China stopped buying U.S. securities, Japan's central bank probably would step in and defend the dollar to protect its own huge export trade with the United States.

17. Is a selloff likely? Nobody thinks so at the moment, but would it take a selloff to drop bond prices and raise interest rates? Nobody thinks so at the moment, but would it take a selloff to drop bond prices and raise interest rates? No, the cutback would do the job fine. No, the cutback would do the job fine.

18. Could we raise the funds by selling additional bonds to other parties? Of course. How can we get other investors to buy more than they currently want? Of course. How can we get other investors to buy more than they currently want? Raise the interest earnings (drop the costs of the bonds). Raise the interest earnings (drop the costs of the bonds).

19. Could we raise the funds by selling additional bonds to other parties? Of course. But when these interest rates go up, what else happens? Of course. But when these interest rates go up, what else happens? Other interest rates in investment markets rise. Crowding-out occurs in private sector investments. Other interest rates in investment markets rise. Crowding-out occurs in private sector investments. Interest rates on housing go up, so the housing boom ends. Interest rates on housing go up, so the housing boom ends.

20. What happens if the housing boom ends and all i rates skyrocket?

21. Fini (The End)

22. Europe’s Labor Markets “European Labor Markets and EMU Challenges Ahead,” Soltwedel, Dohse, and Krieter-Boden. “European Labor Markets and EMU Challenges Ahead,” Soltwedel, Dohse, and Krieter-Boden. Members of the EMU must give up Members of the EMU must give up 1. Monetary policy 1. Monetary policy 2. Currency devaluations 2. Currency devaluations

23. Europe’s Labor Markets With different regional structures, some based on divergent development from scale economies and specialization, regions are subject to different asymmetric (region- specific) shocks, those whose macro impacts affect some regions more than others. With different regional structures, some based on divergent development from scale economies and specialization, regions are subject to different asymmetric (region- specific) shocks, those whose macro impacts affect some regions more than others. Such shocks are more pronounced in the EU at the regional than at the national level. Such shocks are more pronounced in the EU at the regional than at the national level.

24. Europe’s Labor Markets Unemployment also has a regional dimension. The dispersion of regional unemployment rates across the EU was three times higher in 1995 than in the late 1970s. Unemployment in economically troubled regions was three times higher in 1995 than in the late 1970s. Unemployment also has a regional dimension. The dispersion of regional unemployment rates across the EU was three times higher in 1995 than in the late 1970s. Unemployment in economically troubled regions was three times higher in 1995 than in the late 1970s.

25. Europe’s Labor Markets Unemployment is largely a result of the inflexible labor markets in Europe. Unemployment is largely a result of the inflexible labor markets in Europe. Workers once hired are more or less permanent acquisitions. (Legal, institutional impediments to down-sizing.) Workers once hired are more or less permanent acquisitions. (Legal, institutional impediments to down-sizing.) West European workers are costly West European workers are costly (e.g., high, union-encouraged wages, payroll taxes in Germany. Minimum standards for working conditions in the EU’s social charter of 1989.)

26. Europe’s Labor Markets Conclude by discussing the quote on p. 348. Conclude by discussing the quote on p. 348.