Private ECUs potential macro-economic policy dimensions

Introduction

This paper is highly hypothetical. It does not address itself to questions arising out of the present economic environment, but seeks to explore some of the macro-economic policy problems that could occur at some time in the future should ECU-denominated bank deposits and credits come to play an important role in the credit and payments circuits of EMS member countries, accounting for as much as, say, 20 percent of commercial bank assets and liabilities. However, no attempt is made to evaluate the likelihood of the ECU denomination ever attaining such prominence.

The model discussed here is that of a parallel banking market in private ECUs existing alongside the markets in domestic currency deposits and credits. Thus, in each EMS member country banking business would essentially have a dual currency structure, the traditional domestic currency sector dealing primarily, but not exclusively, with residents, and an ECU sector conducting both domestic and cross-border business. While the domestic currency sector would, in a sense, be country specific, the ECU sector would be an integral part of a truly Community-wide market in ECU deposits and credits.

As to the reasons for the attraction of ECU-denominated banking in such a model, it is assumed that ECU business is accorded more favourable regulatory treatment than other foreign currency business and that there are virtually no exchange controls or similar restrictions limiting residents' use of the ECU denomination. Moreover, it is assumed that the demand for ECU deposits and credits is upheld by the Community-wide usability of ECUs for income-generating payments and financial transactions and by their use for hedging or outright "speculative" purposes. And finally, as regards the banks, their interest in providing intermediary services in ECUs may be assumed to be underpinned by the availability of clearing mechanisms, efficient forward markets and perhaps even lender-of-last-resort facilities.

An ECU role within the EMS member countries along the lines indicated in the preceding paragraphs would impinge on macroeconomic processes and the effectiveness of monetary policy in essentially two ways.

Firstly, by providing an alternative to the traditional payments and credit circuits in domestic currency.

Secondly, by affecting the volume and geographical pattern of international (ie cross-border) capital flows.

Although in practice closely interwoven, the implications of these two phenomena are quite different in nature. They are therefore discussed separately in Parts I and II of this paper. Part I assumes for expository purposes that residents of a given country will always build up (or reduce) their bank deposits in ECUs and their ECU borrowing from banks by identical amounts. Part II, by contrast, discusses the macroeconomic consequences of shifts in the net ECU position of a country's non-bank sector. Part III then combines the findings of these two sections to consider briefly whether in such a world of ECU prominence the banks in their ECU operations would command a major autonomous credit and money-creating potential that could undermine the thrust of national monetary policies.

Finally, it may be noted that the analytical approach adopted in this paper is essentially the same as would be appropriate in the case of the Euro-currency markets. There are, however, two differences. One relates to the basket characteristics of the ECU denomination. The other is due to the fact that in the model discussed here ECU deposits, from the point of view of their monetary characteristics, would be much closer and quantitatively more important substitutes for conventional money balances than is at present true of Euro-currency deposits. Nevertheless, despite these differences, many of the findings of this paper would be equally applicable to the Euro-currency market.