50 Years of Capital Mobility in the Eurozone: Breaking the Feldstein-Horioka Puzzle

This paper assesses capital mobility for the Eurozone countries by studying the long-run relationship between domestic investment and savings for the period 1970-2019. Our main goal is to analyze the impact of economic events on capital mobility during this period. We apply the cointegration methodology in a setting that allows us to identify endogenous breaks in the long-run saving-investment relationship. Precisely, the breaks coincide with relevant economic events. We find a downward trend in the saving-investment retention since the 70s for the so-called “core countries”, whereas this trend is not so evident in the peripheral, where the financial and sovereign crises have had a more substantial impact. In addition, our analysis captures other economic events: the Exchange Rate Mechanism (ERM) crisis, the German reunification, the European financial assistance program, and the post-crisis period. Our results also indicate that the original euro design had some flaws that remain unsolved.

One Foot In and One Foot Out, 1990–1997

John Major had none of Thatcher’s reservations about German reunification and wanted to put Britain at the heart of Europe. But he faced growing Euroscepticism inside the Conservative Party. At Maastricht, Major secured for the UK the right to opt out or, later to opt in, to the proposed European single currency. The significance of this opt out for the longer term British sense of detachment from the rest of the EU was not then obvious. The ratification of the Maastricht Treaty in the UK, and the Major government, both nearly foundered, when the UK was forced out of the Exchange Rate Mechanism in 1991. Europe became a toxic issue in the Conservative Party. Mad Cow Disease triggered a policy of non-cooperation by the UK with the rest of the EU. Major championed the enlargement of the EU to include the newly freed countries of eastern and central Europe.

No, No, No

Thatcher got less money back from her EEC partners than she had argued for but secured a lasting deal to replace endless yearly battles for refunds. Arguments over reform of the Common Agricultural Policy (CAP) continued. Thatcher championed economic liberalization in Europe, but was opposed to the Treaty changes needed to bring it about. She compromised and got most of what she wanted, at the price of accepting that economic and monetary union (a single currency) would be pursued. Her attempt at a closer relationship with Kohl and Mitterrand was rebuffed. The Bruges speech created shockwaves around Europe. Thatcher and Howe (Foreign Secretary until 1989) were at odds over Europe. He helped force her to agree to join the Exchange Rate Mechanism (ERM). Her stridency provoked his resignation from government and her downfall. Her policies and legacy tend to be caricatured.

ERM II

From the very beginning, an essential cornerstone of the Economic and Monetary Union (EMU) has been the European Exchange Rate Mechanism II (ERM II). It has been in force since 1 January 1999, ie from the initiation of the third phase of the EMU. Its overall purpose is to link currencies of Member States outside the euro area to the euro. Its importance lies in the fact that aspiring Member States must first join the mechanism for at least two years before being admitted as members of the euro area, as ERM II ‘membership’ is one of the four convergence criteria, which are required to be fulfilled for a Member State’s eventual adoption of the euro.

Doubts about graft could mar Bulgaria’s euro bid

Subject Bulgaria’s moves towards euro adoption. Significance Bulgaria wants to participate in the EU’s Exchange Rate Mechanism (ERM II), which fixes non-euro currencies against the euro within a fluctuation band. Problem-free participation for at least two years is one of the convergence criteria for eventually entering the euro-area. Bulgaria’s motivation is mostly political: to align the country, geographically and economically on the EU’s periphery, with core EU institutions and gain a place at the negotiating table as the post-Brexit EU faces major changes. Impacts All three major ratings agencies class Bulgarian sovereign debt as investment grade (albeit the second-lowest grade) with positive outlook. There are doubts whether Bulgaria can qualify to join the euro within the minimum two years. There is opposition to euro adoption from some shadowy groups preferring a less-regulated, more loosely supervised financial environment. Circles seeking to weaken EU influence and bring Bulgaria closer to Russia will step up efforts to thwart the process.

Article 142 TFEU

Article 124(1) EC Each Member State with a derogation shall treat its exchange-rate policy as a matter of common interest. In so doing, Member States shall take account of the experience acquired in cooperation within the framework of the exchange-rate mechanism.