ben s bernanke : euro at five - ready for a global role? remarks by mr ben s bernanke, member of the board of governors of the us federal reserve system, at the institute for international economics conference, washington, dc, 26 february 2004. the references for the speech can be found on the board of governors of the federal reserve system ’ s website. * * * “ what is the appropriate domain of a currency area? it might seem at first that the question is purely academic since it hardly appears within the realm of political feasibility that national currencies would ever be abandoned in favor of any other arrangement. ” robert a. mundell ( 1961, p. 657 ) it is an honor for me to address such a distinguished group on the occasion of the euro ’ s fifth anniversary. i congratulate the institute of international economics for putting together such an excellent program. the successful introduction, five years ago, of an entirely new currency over a wide range of polities and economies was, at a minimum, a remarkable technical achievement. as a card - carrying member of the club of monetary economists, i like to think that our collective expertise was helpful in making that achievement possible. as both a policymaker and an economist, i welcome this opportunity to look back on the first five years of the euro to see what we can learn from the experience and to consider what this grand experiment implies for the future. i should say at the outset that, as usual, my remarks this evening reflect my own views and not necessarily those of my colleagues in the federal reserve system. 1 the economic analysis of optimal currency areas began, of course, with robert mundell ’ s seminal 1961 paper, from which i have quoted above. 2 as you know, mundell argued that, ideally, economic similarity, not political boundaries, should define the geographic area spanned by a common currency. he was the first to state the classic tradeoff implied by the decision to adopt a common currency. according to mundell, the principal advantage of a common currency is the reduction in transaction costs implied by the use of a common medium of exchange across a broad area. the disadvantage of a common currency is the loss of the shock - absorber properties of flexible exchange rates and independent monetary policies. flexible exchange rates and independent monetary policies will be useful shock absorbers to the extent that macroeconomic shocks are imperfectly correlated across regions, wages and prices are sticky, and other macroeconomic adjustment

” one. this approach has benefits. crises clearly differ in form and severity, which calls for flexibility in the official sector ’ s approach to dealing with them. but discretion also carries some costs. for private creditors, it adds to uncertainty when framing their lending plans. the imf ’ s latest capital markets report states that the private sector is “ highly uncertain, if not outright confused about the official community ’ s approach to achieving its goals ”. discretion also has costs for the official community. it risks “ gaming ” by the private sector, with the official sector providing more money ex - post than would have been optimal ex - ante. by altering official and private sector behaviour in this way, a discretionary approach to crisis management potentially increases both the cost and the incidence of crisis. are there feasible, rules - based alternatives? one simple means of establishing an official “ line - in - the - sand ” would be to place an explicit cap on imf lending. no rule is of course inviolable. but publicly - stated constraints are likely to have greater credibility. this would reduce uncertainty among private creditors. and it would drive home the point that “ bail in ” by private creditors would need to be greater, the larger a country ’ s financing needs, which provides the right set of incentives from a moral hazard perspective. payments standstills as a crisis management tool this limited pool of imf lending would need to be complemented with other crisis management tools. voluntary rollover agreements with creditors - the like of which were put in place in korea and brazil recently - would be an important part of that crisis management toolkit. so too would voluntary bond restructurings, as have recently been undertaken in pakistan, ukraine and ecuador. an ongoing dialogue between country debtors and their private creditors - what the institute for international finance call “ country clubs ” - would facilitate both of these voluntary tools for crisis resolution. involuntary payments suspensions also deserve consideration as part of the official sector ’ s toolkit, however. as a crisis management tool, they may be beneficial in certain situations. where a country is vulnerable to short - term capital movements, standstills could serve as a potentially important circuit - breaker. they might be an efficient means of forestalling “ runs ” on a country because they prevent pessimistic creditor expectations becoming self - fulfilling. more generally, whether capital is short - term or not, they could serve as an important incentive device. having standstills as a