Interest rates, Eurobonds and intra-European exchange rate misalignments in the Eurozone

VINCENT DUWICQUET, JAQUES MAZIER, JAMEL SAADAOUI

Main focus

Adjustment mechanisms in a monetary union characterized by a large heterogeneity.

Northern European countries have accumulated huge current account surpluses, while Southern European countries have run current account deficits.

Strong structural heterogeneity between European countries. Specialization, size productivity, R&D, qualification of the labor

force) Weakest European countries faced difficulties to finance their

deficits as the financial markets feared sovereign debt default. Can not do monetary policy because of the monetary union Financial markets concentrated their attacks on the public bonds.

Methodology

FEER approach: Shows exchange rate misalignments. where some countries extremely undervalued 13% (Germany, Austria, Netherlands and Finland) others increasingly overrvalued (Greece, Portugal, Spain and france) 23%

SFC Model: An asymmetric two-country SFC model of monetary union. Allows a consistent description of assets and liabilities of all

associated real and financial flows. Two countries (n and s) n is five time larger than s

This model introduces the possibility of public federal expenditures and Eurobonds.

Conclussion

European authorities have to react by implementing new economic policies to achieve sustainable adjustments or else:

- Competitiveness loss in southern countries induce stagnation -Diverging current account imbalances and public debt increases

with rising interest rates. Increasing intra-European financing by bank of northern countries

contribute to reduce debt burden, but problem of competitiveness and public debt would not be solved.

Conclussion

Eurobonds could reduce debt burden and public debt would not suffer as bad, which make the Eurobonds scenario an important one. Eurobonds leads to financing large European project which could

impulse strong recovery in the entire Eurozone. Disadvantage: Northern countries fear southern countries would

continue irrelevant policies.

Important aspects to be elaborated

The FEER approach used in this paper is a little unclear, not sure how the calculate the exchange rate