12 - Regional downturns and development and monetary policy

Summary

The increasing liberalization and integration of world capital markets and the establishment of the European Monetary Union (EMU) have raised questions about the ability to use monetary policy to offset an economic downturn (or to limit overheating) in a single country, especially one within a currency union. It is unlikely, for instance, that the European Central Bank (ECB) will lower interest rates, simply to offset an economic downturn in Portugal. Indeed, the fact that governments would have to give up this seemingly powerful instrument is often cited as one of the reasons for not joining a currency union. The counterargument is that with open financial markets, governments really have little discretion in any case; any discrepancy between interest rates in the country and those elsewhere (adjusted for expectations concerning exchange rate changes) will lead to huge capital flows.

The analysis of this book helps us to understand both why regional fluctuations remain important, even in highly integrated economies like the United States, and why national governments still may have some ability to use monetary policy, or more precisely, to affect the flow of credit. It explains why there is still a role for central banks in countries, like Ecuador, that dollarize: for them, there is, after all, life after dollarization.

Credit, as we have repeatedly said, is based on information, and information – especially about small and medium–sized enterprises (SMEs) – is local.