Evaluating the EMS and EMU Using Stochastic Simulations: Some Issues

Abstract

Evaluations of European monetary integration using model simulations have given conflicting results, and the paper attempts to elucidate the reasons for the differences. Several features stand out: how to model realignments; how monetary policy is set for individual countries or for Europe; and how large are risk premium shocks in exchange markets. We quantify the effects of different assumptions relating to these features using MULTIMOD. JEL Classification No.:F31, F471/ We are grateful to Alexander Italianer and Patrick Minford for giving us details of their simulations, and to them and to Leonardo Bartolini, Andrew Hughes Hallett, and Marcus Miller for helpful discussions. We also wish to thank Kote Nikoi and Susanna Mursula for research assistance.

Britain and EMU: Assessing the Costs in Macroeconomic Variability

“…The general conclusion of this work has been that there would be a substantial increase in variability under EMU; the variances of output and inflation are the principal focus of these studies. The earliest independent study was in 1992 by Minford, Rastogi and Hughes Hallett (1993), building on their earlier work in the late 1980s using the Liverpool Multi-country Model and also the UK model; later Masson and Symansky (1992) used the IMF's Multi-Mod, a multi-country model. The range of findings by these authors for European countries generally was quite wide; Masson and Symansky (1992) found rises of inflation variance up to 40 per cent and of output variance up to 30 per cent, Minford et al found very much larger rises, probably because they permitted monetary policy to be optimised in respect of these variances.…”

“…The earliest independent study was in 1992 by Minford, Rastogi and Hughes Hallett (1993), building on their earlier work in the late 1980s using the Liverpool Multi-country Model and also the UK model; later Masson and Symansky (1992) used the IMF's Multi-Mod, a multi-country model. The range of findings by these authors for European countries generally was quite wide; Masson and Symansky (1992) found rises of inflation variance up to 40 per cent and of output variance up to 30 per cent, Minford et al found very much larger rises, probably because they permitted monetary policy to be optimised in respect of these variances. The EU Commission (1990, Annex E) also published a study of this type which purported to find that EMU actually reduced macro variability; their methods were strongly criticised by these other authors on the grounds that they had unrealistically over-estimated the variances of the risk-premia on national EU currencies which of course disappear on entry into EMU.…”

“…To assume it in a stochastic simulation exercise like this one will in practice make the assumed risk-premium excessively volatile by a large margin. A similar assumption was used by the EU Commission, 1990, in its initial stochastic simulation exercise where it dramatically biased the results in favour of EMU; it was strongly criticised by Minford et al (1993) and also rejected by Masson and Symansky (1992).…”

EMU and Transatlantic Exchange Rate Stability

“…At first sight, this solution is consistent with the rational expectations used in the simulations. But rational expectations at time t are based on the available information, while the actual exchange rate at t+1 depends on the news in t+1, which cannot be expected in t: the news at t+1 should not impact on the exchange rate at t. This first solution is rejected by the EC (1990), Minford et al (1990) and Masson and Symansky (1992). .…”

Optimal Currency Areas Scottish Economic Society/Royal Bank of Scotland Annual Lecture, 1999

“…Evidence on the magnitude and persistence of asymmetric shocks, and convincing evidence on the nature and source of these shocks is hard to find, despite a growing number of empirical studies devoted to this subject (see eg, Minford and Rastogi, 1990;De Grauwe and Vanhaverbeke, 1991;Minford, Rastogi and Hughes Hallet, 1993;Masson and Symansky, 1993;Bayoumi and Eichengreen, 1993;Erkel-Rousse and Melitz, 1995;Gerlach and Smets, 1995;Bhattacharya and Binner, 1998). Most of the earlier studies failed to distinguish between LM shocks and IS shocks, and even the more recent studies that do, such as Erkel-Rousse and Melitz (1995) and Bhattacharya and Binner (1998), have to resort to heroic identification restrictions that fail to convince.…”