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PIIE Update Newsletter
June 16, 2010
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Policy Brief 10-14
In Defense of Europe's Grand Bargain
[pdf]
Jacob Funk Kirkegaard
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The current European economic crisis is principally fiscal in nature. During the weekend of May 8–9, 2010, European leaders crafted a very important and constructive political "grand bargain" between EU member states and the European Central Bank (ECB) with far reaching, positive implications for the credibility of the European Union's fiscal policy framework and the long-term sustainability of European government finances. There is no chance that the eurozone will break up as a result of the current economic crisis and in the long term from the effects of the grand bargain. Leaving the euro will come at catastrophic cost to any nation that tries to do so out of economic weakness. If Greece is ultimately forced to default on its debts, it is certain the Greek government would want to do it within the eurozone. As such, a Greek default poses no risk to the composition of the eurozone, which considering that a German departure is equally unlikely is a secure monetary union.
Kirkegaard suggests a set of required next steps for Europe: (1) European governments must immediately begin to address the lingering uncertainties surrounding the capital adequacy of the eurozone banking system; (2) it is crucial that eurozone governments, particularly among the Southern members, deliver expeditiously on the austerity and not least structural reform commitments recently made; and (3) the eurozone should consider introducing a potential "carrot" for members that successfully manage to put their government finances on a sustainable path. This carrot could come in the form of a future common "Maastricht bond," similar to the often suggested "eurobond," but open only to eurozone members that actually adhere to the Maastricht Treaty debt stock criteria of a maximum level of government debt of 60 percent over an entire business cycle. A successfully launched pan-European Maastricht bond, backed by the credibility of years of painfully endured austerity measures across a sufficient number of participating member states, could achieve a scale and market depth not far off today's US treasury market. A Maastricht bond could consequently pose the first serious threat to an increasingly fragile US treasury market as the "global safe haven" asset.
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Read full policy brief [pdf]
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Working Paper 10-9
US Trade and Wages: The Misleading Implications of Conventional Trade Theory
[pdf]
Lawrence Edwards and
Robert Z. Lawrence
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Lawrence Edwards and Robert Z. Lawrence find that fears that US wage inequality is rising due to developing-country imports are not consistent with the evidence. They emphasize that while conventional trade theory makes such expectations plausible, the theory depends on the assumption that the United States and developing countries produce similar products. The authors find that over the past decade effective unskilled worker–weighted prices of US manufactured goods have actually risen relative to skilled worker–weighted prices, which suggests pressures for increased wage equality. They also use a two-stage regression procedure to isolate the impact of developing country imports. They find that these have not mandated more unequal US wages. These outcomes can be explained if the goods exported by developing countries are not close substitutes for the goods produced by developed countries. This means that for the most part, unskilled US workers are not competing directly with their developing-country counterparts.
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Read full working paper [pdf]
>> See also Working Paper 10-8: Do Developed and Developing Countries Compete Head to Head in High Tech? [pdf]
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Policy Brief 10-15
Estimates of Fundamental Equilibrium Exchange Rates, May 2010
[pdf]
William R. Cline and
John Williamson
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This policy brief updates Cline and Williamson's estimates of fundamental equilibrium exchange rates (FEERs) to May 2010 using the data to March contained in the April issue of the International Monetary Fund's World Economic Outlook. The IMF's data are updated to May to take account of subsequent exchange rate changes and Cline's estimates of the impact of exchange rate changes on trade flows. In addition, the assumptions about current account targets have been somewhat modified from previous years: All countries are now assumed to aim to keep current account balances within 3 percent of equilibrium, whereas formerly some countries with large net foreign assets to GDP ratios (NFA/GDP) were allowed larger targeted imbalances. The fundamental question explored is what pattern of exchange rates is consistent with satisfactory medium-term evolution of the world economy, interpreted as achieving those objectives while maintaining internal balance in each country.
The big disequilibrium in the pattern of exchange rates remains the undervaluation of the renminbi and the overvaluation of the dollar. The size of the Chinese disequilibrium is, however, less than previously estimated (now 15 percent on an effective basis and 24 percent bilaterally with respect to the dollar), due to the decline in the IMF's estimate of China's prospective current account surplus. The recent depreciation of the euro, while increasing the size of Euroland's prospective surplus, does not threaten to lead to an internationally unacceptable imbalance (i.e., greater than 3 percent of GDP) and therefore does not create a case for international action to reverse the rise. The yen is no longer found to be overvalued on an effective basis, although if China revalued that would create a case for a stronger yen/dollar rate. Several of the other East Asian currencies would also need to appreciate bilaterally to avoid effective undervaluation. Of the 28 other economies covered, Hong Kong, Malaysia, Singapore, Sweden, Switzerland, and Taiwan are judged to need an effective appreciation and Australia, Brazil, New Zealand, South Africa, and Turkey to need an effective depreciation.
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Read full policy brief [pdf]
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Peterson Perspectives Interviews
A Return to Global Imbalances?
C. Fred Bergsten says that a weaker euro and an undervalued Chinese renminbi threaten to magnify the US current account deficit and undercut the G-20's pledge not to revive global imbalances.
Preview of Our Next Issue
Speech
When Central Banks Buy Bonds: Independence and the Power to Say No
[pdf]
Adam S. Posen
Op-ed
Will the New Climate Bill Damage US Energy Security?
Trevor Houser and Michael A. Levi
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Peterson Institute for International Economics
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