Two identical countries A and B share a common (paper) currency C. The demand for currency is 5% of annual (Nominal) GDP.
Suppose B decides to quit the currency union and print its own currency. There are two different ways it could do this:
1. Convert and destroy. The people in B convert their C notes into their government's newly-printed B notes, and their government then destroys the C notes it has collected. The two countries carry on as before.
2. Print and spend. The people in B convert their C notes into B notes, and their government spends the C notes in country A. Or the government in B prints and spends the new B notes, and the people in B spend their unwanted C notes in country A. ("Spend" could include buying assets, including financial assets, and not just spending on newly-produced goods). Either country A now faces a doubling of the price level, which imposes a 5% of NGDP inflation tax on the people of country A, or else the government in country A increases taxes or sells assets worth 5% of GDP to prevent the supply of currency doubling.
By following the "print and spend" option, instead of the "convert and destroy" option, country B imposes a one-time tax of 5% of annual GDP on country A.
I haven't been following their disagreement very closely, but I think I'm agreeing with Hans-Werner Sinn and disagreeing with Karl Whelan. Institutional details like Target2 just encloud what is at root a very simple story.
It is extremely unlikely that the government of a country like Greece, in current circumstances, would follow anything like "convert and destroy".
But Greece is a small country, and 5% of a small country's NGDP is an even smaller percentage of a bigger country's NGDP. And it will be an even smaller percentage if Greeks continue to hold Euros as well as Drachmas. But magnitudes aside, it has the same effect as one more default.
If country A suspects that country B is planning to follow a "print and spend" exit from the common currency, it might want to jump ship first, so it is country B that makes the transfer to country A. There are incentives for a "currency run" at the supra-national level. Last one left holding the common currency is the sucker.
Of course, if there is initially a recession caused by an excess demand for the medium of exchange, there's a silver lining in all this "excess supply" of currency.
Worthwhile Canadian Initiative 
If the people in B had 100 C notes, they must have gotten them by giving bonds worth 100 C notes to the central bank of the (former) currency union, so the government of B wouldn’t destroy the 100 C notes it collected. It would redeem them at the central bank for the 100 C notes worth of bonds it had previously paid to the central bank.
If B’s money printing results in stimulus of presently idle productive capacity in country A, there is no “inflation tax.” Just an increase in overall spending levels in country B, recorded as net positive claims on an increased amount of productive output in country A. Essentially South-to-North FDI. Win-win.
It all depends on how the various pieces of the Greek central bank balance sheet (which is part of the Euro system of central bank balance sheets) are resolved in the transition to a new stand-alone central bank balance sheet in a post exit scenario (where it is obviously not part of that system).
Nobody’s even talking about that, but Sinn is right that resolution of the existing Target2 liability matters a lot.
You’re overlooking that by leaving the euro, Greece would forfeit its part ownership of the ECB. The last country to leave the euro would presumably own 100% of the ECB. Perhaps the details haven’t been worked out in advance, but this is the only thing that makes sense.
Now there’s one detail that complicates this logic. Greece is indebted to the ECB. If it defaults, the ECB can recover its loss by withholding dividends to Greece. So under these circumstances, Greece has less to lose by leaving the euro.
I’m not overlooking that at all.
The Greek participation in Eurosystem seigniorage is based on the Greek central bank capital key – not on the actual balance sheet structure or its own profit results. The same point applies to the marginal effect of issuing banknotes, where there is a sharing formula based on the capital key.
The fact remains that the German banking system is funding the Greek banking system through Target2.
This is an issue particularly if Greece just walks away from the principal amount of that funding liability – in addition to the rest of its default fallout.
Coppola had a interesting and good post on this. I have a different point of view and thus kind of disagree but I think it depends how we view the union in the first place:
http://coppolacomment.blogspot.fi/2015/06/oh-dear-professor-sinn.html
Mike: Let’s see:
In the beginning, the government of B wrote “IOU 100 C notes” on a bit of paper, gave it to the Bank of C, and the BoC gave the government of B 100 C notes in exchange. (The government of A does the same.)
Under “Convert and Destroy”: the government of B prints 100 B notes, gives them to its people in exchange for the 100 C notes they hold, and gives the BoC those 100 C notes in exchange for the IOU for 100 C notes held by the BoC. The BoC then burns those 100 C notes, and the government of B burns the IOU. Everything carries on as before.
Under “Print and Spend”: the government (or people) of B spends those 100 C notes in country A. And when the BoC asks the government of B to honour its IOU for 100 C notes, the government of B tells the BoC to get stuffed. [Update: in which case, the BoC has 200 C notes in liabilities, and only 100 C notes in assets, so the government of A will need to give the BoC an extra 100 C notes in IOUs as a freebie, to prevent inflation, according to Mike’s Backing Theory.]
I think that’s right.
In my above comment, I’m trying to translate what I said in Quantity Theoretic language into Mike’s Backing Theoretic language. I think (in this case) we get the same outcome in either language (if I did the translation right).
In the 1690s the Massachusetts colony began printing and coining its own currency. The main reason is that they were strapped for cash. Not enough British currency was circulating in the colonies, which is one reason why the Spanish dollar was a major currency here. The British Crown told them to stop or be charged with treason, as sovereignty belonged to the crown. Was the Massachusetts currency effectively a tax on Britain?
In lawyerly fashion Massachusetts starting issuing IOUs which it would accept in payment of taxes, effectively creating a fiat currency without calling it one. Was that a tax on Britain?
Later other colonies began issuing their own fiat currencies. The result was an increase in economic activity in the colonies, and general prosperity. Were those also taxes on Britain?
In times of insufficient money local currencies have proven to be effective without the local inhabitants destroying whatever other money they had. Businesses issue coupons, savings stamps, airline miles, credit card points. Are all of these in effect taxation on those who do not receive these benefits?
There is no question that there is not enough money circulating in Greece. The so-called bailouts of recent years went mostly to French and German banks. Under such circumstances would the creation of more money in Greece effectively be a tax on other Euro countries?
Ro and Min: that’s what I meant by my “silver lining” sentence at the very end.
Jussi: I had a skim of Frances C’s post, but her accounting and institutional detail is too complicated for little old me. I think we need to start with a very simple example, like my QT example, or Mike’s BT example, look at the two possible outcomes, and then try to decide which of those two possibilities is closest to actual Greece.
Now I’ve got the Stooges’ Search and Destroy stuck in my head.
I think I’m agreeing with JKH.
Nick, I think the most important take away (aside of thorough technicalities) from Frances is that if Euroarea were a real currency union it wouldn’t even record T2-balances. She didn’t try to defy account, i.e. basis of QT / BT interpretation, which I agree is a useful way to start thinking about the effects. Maybe it was actually off-topic but, IMO, interesting point of view anyway.
“B prints 100 B notes, gives them to its people in exchange for the 100 C notes they hold, and gives the BoC those 100 C notes in exchange for the IOU for 100 C notes held by the BoC.”
I think that’s right and from BT’s point of view it doesn’t make a difference in terms of price level whether B defaults its bond owned by the BoC or B prints and spends as you described.
But Is there a reverse QT translation how B defaulting bonds owned by A’s central bank will change A’s price level!?
It doesn’t make sense to pay back part and simultaneously default other part of existing debt. I vote ‘print and spend’.
Jussi: it was definitely on-topic.
“…from Frances is that if Euroarea were a real currency union it wouldn’t even record T2-balances.”
I think that relates to the discussion between me and Mike above. Mike’s approach looks at the assets (and liabilities) on the central bank’s balance sheet, while my approach sets them aside. But I think I have shown above that we get to basically the same answer either way, as long as we do it consistently. What I wonder (this is pure speculation) is whether Frances C has switched between those two approaches halfway though.
There is another possibility.
I think a critical mechanical question is “Who backed the currency recently issued to Greek citizens?”. According to wiki, all currency is labeled with the name of the issuing nation, encoded into the serial number. https://en.wikipedia.org/wiki/Euro_banknotes
Greek issued currency will have a “Y” as the initial letter in the serial number. In addition, “The remaining 11 characters are numbers which, when their digital root is calculated, give a checksum also particular to that country.” (from the above link).
It seems to me that if a link to a Greek backed account (or currency issue) can be found, each Greek monetary unit may be potentially discounted. Of course, such a discounting would be laborious but if a link exists, it can be followed.
As another commentator said (in a comment on a Coppola post), any effort to follow euro national issuance would be destructive to the euro goals. Unfortunately, we are in unusual times and unusual things are occurring.
Roger: Let’s just assume that the Y notes are indeed the liability of the government of Greece, and get separated out. If they become worthless, then that is the form the inflation tax would take under “print and spend”.
If the Wikipedia article is correct ( https://en.wikipedia.org/wiki/Euro_banknotes ) then all currency presently in use is labeled. If correct, Greece is presently printing it’s own currency. The euro union is a mechanism attempting to assign a common value to one unit (the euro) which can be accepted no matter which nation issued the currency.
It seems to me that euro deposits held in banks would be harder to identify in terms of nation of issue. Obviously, Greek banks would be suspect. Deposit holders with Greek addresses could also be suspect.
Someone is likely to lose money with any Greek default. Who will these unfortunate people be and will the losses be limited to bank holders?
Frances’ main point seems to have been to reject Sinn’s interpretation of Target2 liabilities. She’s wrong on that particular point and he’s right, IMO.
A “real currency union” is a non-idea. There is no set architecture. The fact that the Eurozone fails on fiscal design doesn’t mean it’s not a currency union.
The Euro system includes a set of countries, each with its own banking system and its own central bank. The various national central banks take their policy marching orders from the ECB, which also has its own separate balance sheet.
The fact is that with a 100 billion Target2 liability, the Greek banking system is overdraft to the rest of the Euro system. That overdraft has been “plugged” by ELA loans to Greek banks. This is really just a fancy device in effect for recognizing the funding aspect of an overdraft in the first place.
There is a clear analogy with a single commercial banking system such as Canada’s.
If a depositor at BMO takes his money to Royal, and nothing else happens, BMO is overdraft in its Bank of Canada account. Royal has a surplus reserve position. The Bank of Canada will “plug” that BMO overdraft with a formal advance.
If a depositor at a Greek bank wires his money to Germany, and nothing else happens, the Greek bank is overdraft at the Bank of Greece and the Bank of Greece is overdraft at the Target2 clearing system. The Greek commercial bank has lost deposits (a liability) and the Greek central bank has lost reserves (a liability). A bank in Germany has a surplus position in deposits (an asset) with the Bundesbank, and the Bundesbank has a surplus position in Target2 balances (an asset) at Target2.
The German banking system is funding the Greek banking system in this situation, via the Target2 clearing system. It is analogous to the example where the Royal is funding BMO – at the margin – via the Bank of Canada clearing system.
The Greek central bank has lost reserves (a liability) to another banking system; BMO has lost a deposit (a liability) to another bank. In both cases, there is a risk sharing procedure embedded in the rules for the clearing system, which stands between the two counterparties that created the effect.
These are both currency unions.
Germany’s Target2 surplus position is not “funny money” – any more than the Royal’s surplus at the Bank of Canada is “funny money”. It is funding provided from Germany to Greece via Target 2 in that example. Unless Greece can cover its deficit with private sector funding, it is being funded by Germany at the margin. And unless the BMO can cover its deficit with private sector funding, it is being funded by the Royal Bank – at the margin in this example – via the Bank of Canada.
The difference lies in the operating expectation for such coverage according to the rules.
The Bank of Canada wouldn’t take kindly to persistent BMO short position. The Eurozone is more tolerable – provided that the system continues to operate for all participants. Target2 exposures are formally open ended.
But that must change if the participant “leaves” the system.
If BMO “left” the Canadian banking system and declared its own currency, there would be a considerable clean-up operation required with respect to its Bank of Canada short position in Canadian dollars. It owes that money to the rest of the system. And the Royal doesn’t want to be told it has to “write off” the value of its surplus reserve position.
Neither does Germany want to be told something similar. If Greece leaves, that sort of cleanup is required. It owes that money – in Euros – to the rest of the Euro system. It is not “funny money” at that point or at any other point.
That is Sinn’s point on Target2.
JKH: your good analogy clarifies things for me.
(I edited it very slightly to put the apostrophe in France’s in the right place, because that threw me momentarily, when I thought you were talking about the country!)
Is there a way to frame what is happening with Greece as a natural experiment to either validate or invalidate different macro models? For example, are there some possible outcomes that would be consistent with monetarist models but inconsistent with new Keynesian models (or vice versa)? If so, any examples?
Tom: for a good natural experiment, you need some sort of random exogenous shock (or, a shock that was unrelated to any other economic variables that might also affect what happens). That doesn’t seem plausible for Greece. It was no accident it happens in Greece first. And I don’t see any massive disagreement between monetarists and New Keynesians on what will happen. Our own uncertainties are bigger than any differences. Our projections overlap theirs.
JKH: my own approach (in the post) was consistently funny money all the way through. My translation of Mike’s point in comments above was consistently serious money (backed money) all the way through. In both cases we get the same two answers, with the second answer much more likely for Greece. Your own approach is consistently serious money all the way through, and you too get the same two answers, with the second answer more likely for Greece.
I am now more suspicious that Frances may be switching back and forth between funny and serious money.
“Mike’s approach looks at the assets (and liabilities) on the central bank’s balance sheet, while my approach sets them aside. But I think I have shown above that we get to basically the same answer either way, as long as we do it consistently.”
I agree and it is a good catch.
But I think from BT’s point of view both sides of the CB’s balance sheet are important. QT seems to be only about liability side, yet in this example you was able to reconcile both views when there was a loss in (A’s) liability side (B defaulted a bond on A’s balance sheet). Can there be even more common ground that?
I agree with JKH/Sinn – in theory and from accounting point of view.
“A “real currency union” is a non-idea”.
Yes, I agree but it was just a quick comment – my waste of space not Frances’s.
But I think the heart of the question is that Frances had a different interpretation of the currency area than Sinn. And it is IMO related whether the currency area can be viewed “real” in the sense that it is indeed deemed as irreversible – as for instance Draghi is repeating.
My interpretation of an irreversible is that given certain economic qualities, apart from optimum currency area, there needs to be certain functions (like fiscal transfers) in place such that the currency area can be expected to survive through economical and political cycles. On other words there is a set of conditions an irreversible less than optimum currency area needs to fulfill. This is vague but I think most of us agree that gold standard didn’t work – Euro is similar in many ways and now has similar symptoms. I think given Europe less than ideal mobility, fiscal transfers are needed, even more than in the US.
Nothing above is meant to refute JKH’s observation that “There is no set architecture” for a currency area. Yes, but can we view all the architectures as irreversible?
Given above I think Euro design with the targer2 balances, if not taken as symbolic, cannot be viewed as irreversible currency area. It will be just a reversible peg between sovereigns without real commitment and trust. If that was Frances idea in broad terms, I agree with her.
Anyway, I would emphasis that all the interpretations are mine not hers. Go and read her post(s).
Above:
“… (A’s) liability side (B defaulted a bond on A’s balance sheet).”
Should be:
“… (A’s) asset side (B defaulted a bond on A’s balance sheet).”
JKH, sorry, I was replying to Nick.
In Nick’s hypothetical, country B would initially be entitled to 50% of the union central bank’s dividends. After leaving, it’s entitled to 0%, but gets 100% of its national central bank’s dividends. It’s a wash.
“It is extremely unlikely that the government of a country like Greece, in current circumstances, would follow anything like “convert and destroy”.”
Why’s that? If Greece is going to default on its IMF loans, why not default on its Target2 balances owing too?
JP: “convert and destroy”, when translated, means Greece would honour its Target2 liabilities.
Max: (I misunderstood too). That bit is indeed a wash. But the one-time transfer of 5% of GDP (under “print and spend”) is over and above that.
Right, understood. Good post.
Nick: assume for simplicity that the central bank operates with zero capital, assets=liabilities. When the union dissolves, the central bank sells half its assets (which destroys half the currency), and cuts its dividends in half. But Country A then will receive 100% of the dividends, rather than the 50% it was receiving before. No change in wealth.
If the central bank’s assets consist of equal parts Country A and B treasury bonds, and Country B exits AND defaults, then yes, the leaving country would benefit.
Max: OK. And then country B sets up a new central bank, which sells B currency in exchange for the bonds the BoC sold to the public. It’s exactly like “convert and destroy”, except the BoC did half of the converting and destroying.
What happens if the ECB basically repudiates all Greek euros? Declares that it will not accept any Euro bill printed by Greece, and that all post-Grexit euro transfers from Greek banks to non-Greek banks/entities will be discounted by however much the drachma has depreciated since Grexit. This would essentially force the convert-and-destroy option, wouldn’t it? (If country B can’t spend its C notes/deposits at par, then they are effectively the same as B’s new currency, as far as the outside world is concerned. And given that, B’s citizens will quickly treat any remaining C notes/deposits the same way.) The only remaining “true euro” currency in Greece would be those physical notes which had migrated into the country previous to Grexit.
“it will not accept any Euro bill printed by Greece”
This is interesting thought experiment but you have to remember that most of euros printed in Greece are already somewhere else. It would be complicated too in many ways. A lot of money has already ran away. It would create a horrible precedent.
One should keep in mind there is no such thing as a “bill printed by Greece”, only a bill printed in Greece as a liability of the ECB and euro system as a whole.
“This would essentially force the convert-and-destroy option”
I don’t think so, it would penalize some currency / deposit holders in Greece (and elsewhere) but it wouldn’t match to the amount of liabilities Greece and Bank of Greece could default. In Nick’s model the whole amount of C notes, not just the discounted amount, should be written off before A wouldn’t be affected.
“the whole amount of C notes, not just the discounted amount, should be written off before A wouldn’t be affected.”
Should be:
“the whole amount of C notes owned by the country B, not just the discounted amount, should be written off before A wouldn’t be affected.”
Nick: France Coppola’s post explain why I tell my macro students that one of the two or three concepts they must master, if necessary at the expense of everything else, is the balance of payments.
In the canadian context, can you imagine the political consequences if the designers of the equalization payments system had decided to create an interprovincial set of accounts similar to Target2 instead of routing it through the federal budget? It would have all the Target 2 system’ defects, including not taking into account the cause of the imbalance (misaligned exchange rates.) Recriminations are already loud enough.
Nick:
Your “convert and destroy” scenario sounds right, but then under “print and spend” you say:
“the government of B tells the BoC to get stuffed”
This creates a whole bunch of variables, and a whole bunch of scenarios. Maybe B tells BoC to get stuffed before B tries to spend its BoC notes in A, or maybe the BoC notes issued for B’s bonds have an identifying letter “Y” on them, and people value them according to their estimation of B’s financial health.
Let’s focus on the “print and spend” scenario as you originally stated it, which did not mention anything about getting stuffed (not explicitly anyway).
The government of B could only issue B notes if it had assets to cover them (bonds issued by IBM, let’s say). So there are 200 C notes (all held in country A) backed by bonds worth 200 C notes, and 100 B notes, backed by IBM bonds worth 100 C notes, so no inflation. But assuming the public desires real balances of only 200 C notes, 100 notes must reflux to their issuer.
“Recriminations are already loud enough.”
It does matter whether target2 claims are recorded only as a continuum of pre-euro style of accounting or are they recorded for an anticipated break-up?
I think Frances was saying, and I agree, we should mind the political commitment – Euro was meant to be irreversible. Thus target2 claims are just a bizarre accounting convention to be ignored. The claims are not funny money but should be accounted as a common liabilities.
The notion of “irreversibility” seems oxymoronic in context – apparently Grexit is imaginable.
There is a question of a legacy balance sheet for a central bank participant whose sovereign connection has abandoned the multi-central bank system and proceeded to set up its own currency and its own independent central banking operations. The lawyers would be all over the question of how to deal with that legacy balance sheet – who “owns” it (e.g. Greece or the ex-Greece Euro system) and according to what conversional/transitional financial adjustments?
The fact is that currency C now becomes a foreign currency for country B. And for example just to be able to redeem currency from the legacy balance sheet, B has to be able to credit commercial bank accounts with deposits in currency C – deposit accounts that can no longer be considered to be regular reserve accounts in the Euro system. They become nostro accounts in a foreign exchange system. That’s just for starters.
It gets very messy. To shrink that legacy balance sheet, assets must be sold/matured in order to generate the Euros to shrink the liability side. This is consistent with the BT view – which seems more fact than view.
One possibility might be to wind up the entire Greek NCB balance sheet and move it over to the ECB balance sheet as a legacy position there. But a valuation must be put on it (by lawyers and accountants) in order to do that. It becomes a question of who owes whom in completing that sort of transaction. Both the Target2 liability and the currency liability must be taken into account and covered by either the value of the associated asset transfer or by an additional debt of Greece to the Euro system if asset coverage for those liabilities is inadequate.
I don’t think the Target2 system is bizarre. It is merely a clearing system for multiple central banks who are exposed to losing or gaining reserve liability positions against each other (analogous to multiple commercial banks with the same exposure in deposit liabilities via a single central bank). It is a necessity for clearing operations in that multiple central bank context – which is quite separate from the consideration of fiscal arrangements beyond that. The only reason Canada doesn’t have such a system is that each province does not have its own central bank.
Nick –
sorry for the institutional/accounting thickets
remember Arte Johnson playing the German solder on “Rowan and Martin’s Laugh-In” ?
“very interesting”
JKH: “The only reason Canada doesn’t have such a system is that each province does not have its own central bank.”
Minor addendum. Following your initial analogy. In a sense, Canada does have one. It’s just that nobody bothers to aggregate the data provincially. Suppose BMO has branches in all provinces. Suppose the depositors in PEI have negative balances, and those in other provinces have positive balances. If BMO gets wound up (or if the people in PEI decide they want to switch to another bank), the people in PEI can’t just walk away from those negative balances.
Or, suppose that Canadian Banks were restricted to operating in one province only. If BNS had a negative balance on the books of the BoC, that would be like Greece on Target2.
JKH: this is a case where I really like you wading through those institutional/accounting thickets. So I don’t have to even try (and get it wrong)!
Arte Johnson in that role was second only to Goldie Hawn, to my teenage mind.
Nick,
And the chartered banks have the flexibility to configure their internal management accounting to depict asset-liability mismatches by province of domicile – probably to the point of determining daily clearing results and mismatch changes by province if that were desired.
But even chartered banks have centralized fiscal operations.
good post by JP Koning:
http://jpkoning.blogspot.ca/2015/06/euros-without-eurozone.html
Yep: I was wondering how to put JP and Warren Mosler’s business cards together.
Thanks JKH, well explained.
I have got an impression that NCBs (and thus their assets) are “owned” by the respective member state and thus distribute their profits to their member state. But they are also a part of the Euro system being owner/equity holders of the ECB (https://en.wikipedia.org/wiki/European_Central_Bank). So Nick is, IMO, right about the last one being the sucker.
“The notion of “irreversibility” seems oxymoronic in context – apparently Grexit is imaginable.”
I think “irreversibility” should be seen as a part of political rhetoric – as a strong commitment to keep all the member states on board. I see contradiction between extra layer of accounting which counts everything to a penny between member states and the idea of irreversibility. Given political commitment and perpetual nature of the target2 claims I think we should view them as common liabilities.
I think the following is true (JKH?):
The flows incurring target2 claims (by quadruple-entry accounting and all) are typically deposit transactions between private entities (e.g. transaction from Greece to Germany). Deposits are common liabilities of the whole Euro system. If the private cross-border transaction incurs forceable target2 claims it seems that Euro deposits doesn’t in all cases offer a way to make true final payment? In other words in the Euro system a citizen might need to pay the cross-border payment twice, first as a private transaction and second time through taxes intended to cover target2 claims in the case of break-up?
The Greek central bank has lost reserves (a liability) to another banking system; BMO has lost a deposit (a liability) to another bank. In both cases, there is a risk sharing procedure embedded in the rules for the clearing system, which stands between the two counterparties that created the effect.
Shared risk means that the burden of a fallout would have to be shared, too.
But you write It owes that money – in Euros – to the rest of the Euro system, which implies that the burden lies only with the party that leaves the system. Hans-Werner, is that you?
The Bank of Canada wouldn’t take kindly to persistent BMO short position. The Eurozone is more tolerable – provided that the system continues to operate for all participants. Target2 exposures are formally open ended.
But that must change if the participant “leaves” the system.
The bank of Canada also has clearly defined measures it can take to limit system imbalances whereas within the Eurozone, as you state, no such formal steps were defined (?). Nor do the national central banks have any power to counter ouflows, say with an independent monetary policy. Formally open ended is a euphemism for: do whatever you want, it doesn’t matter, nor can you do anything about it. And if it doesn’t matter now, how can it matter later?
What strikes me about the Euro construction is that you have a completely shackled national entity (NCBs) stuck in between a layer of supranational technocracy with a one-dimensional mandate (ECB) and private commercial banks that lack unified oversight and a unified legal foundation.
The hope, I suspect, was that the convergence criteria of the stability and growth pact would eliminate the possibility of asymmetric shocks happening in the first place. It’s been a long time since I’ve herad anybody use the term convergence criteria to describe the Euro system. I wonder why…
I guess Coppola’s idea of a ‘real’ currency union is one in which cross border controls are not even recorded (because there aren’t any national central banks nor are banks registered with a nation state) and so cannot be claimed when a nation leaves the system. Nations and banks are completely separate entities. Upon leaving, the newly formed nation just gets back its original buy-in at the central bank and converts all other assets and liabilites on the books of whichever banks happen to join in into the new currency. They could all stay within the Eurozone but would have to set up headquarters outside of Greece, I guess. Not sure whether that’s technically possible. It’s certainly not how the Euro system is set up now. But I think Coppola is trying to say that a ‘real’ currency union should be thought of that way.
Jussi,
Roughly speaking, there is a sharing of aggregate Eurozone NCB financial results according to capital contributions by country. It is not a direct contribution from each NCB to its respective country treasury. It is risk sharing instead.
The answer to the last point depends on the mechanics of balance sheet resolution. The assets of a legacy position would be available to pay off the liability position that includes Target2. A key point is that an ex-Greece Eurozone going forward would have no interest in retaining a legacy position that includes loans to Greek banks and funding from the rest of the Eurozone. It would want to see resolution and repayment of those loans so that it has no Greek lending on the balance sheet, and consequent repayment of the Target2 position. A similar point applies to Euro currency issued from the legacy balance sheet, although the resolution of that also depends on currency redemption coming in. Rather messy.
An interesting wrinkle is that the ELA loans to the Greek banks are on the books of the Greek NCB but loans losses in this case are strictly for the account of Greece (a policy imposed by the ECB) – i.e. such losses will not be shared and are outside of the normal risk sharing formula for the Eurozone. That puts the Greek state on the hook for ensuring that an equivalent amount is available to repay those loans so that Target2 can be repaid to the rest of the Eurozone. That’s one way that the balance sheet would imply a future tax liability as well. Of course, Greece supposedly has the option of defaulting on everything under the sun, including that Target2 liability.
I don’t know what a “real” currency union is.
The United States?
Canada?
Since when did we start talking about those two as currency unions – other than since they started to be used as analogous and not so analogous comparisons with the Eurozone?
To the extent that that’s a reply to my point, you’re right, of course. I was just trying to capture her spirit while agreeing with you, technically.
JKH: Canada and US are currency unions. Their regions have different economic cycles, different patterns of trade within and without the common currency area. If they had different currencies, their exchange rates would fluctuate.
We get around that with fiscal federalism in its many guises, both open and covert. Which is why few people ever noticed.
Neither chartered banks or official institutions compile a balance of payments between provinces or states,though researchers do it (PK frequently use them).
Thank God for the recriminations would be endless. In fact we have them in the form of who pays for equalization (forgetting why equalization is needed).