Hal S. Scott is the Nomura Professor and Director of the Program on International Financial Systems at Harvard Law School, where he has taught since 1975



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Hal Scott
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Hal S. Scott is the Nomura Professor and Director of the Program on International Financial Systems at Harvard Law School, where he has taught since 1975. He teaches courses on Banking Regulation, Securities Regulation, International Finance and the Payment System. During the 2004-2005 academic year, he is a Visiting Professor at the Woodrow Wilson School at Princeton University.
He has a B.A. from Princeton University (Woodrow Wilson School, 1965), an M.A. from Stanford University in Political Science (1967), and a J.D. from the University of Chicago Law School (1972). He is been admitted to practice in Massachusetts and various federal courts.
The Program on International Financial Systems engages in a variety of research. It is currently completing a study of worldwide capital adequacy rules for banks, insurance companies and securities firms. The Program also organizes the annual invitation-only U.S.- Japan and U.S.- Europe, and U.S.-China Symposia on Building the Financial System of the 21st Century, attended by financial system leaders in the three countries. The Program also directs a concentration in International Finance for LLM students at Harvard Law School.
Professor Scott=s books include the law school textbook International Finance: Transactions, Policy and Regulation (11th ed. Foundation Press 2004) and International Finance: Policy and Regulation (Sweet & Maxwell 2004). He is the editor and a contributor to Capital Adequacy Beyond Basel: Banking, Securities and Insurance (Oxford University Press, forthcoming 2004). He is also an author and editor of Asian Money Markets (Oxford 1995). His recent articles include A Bankruptcy Procedure for Sovereign Debtors?, 37 The International Lawyer 103 (2003) and Internationalization of Primary Public Securities Markets Revisited, in Capital Markets in the Age of the Euro: Cross-Border Transactions, Listed Companies and Regulation, eds. K Hopt, E. Wymeersch and G. Ferrarini (Kluwer 2002).
Professor Scott is a Governor of the American Stock Exchange and a member of the Shadow Financial Regulatory Committee. He has served as a consultant to a variety of financial institutions, multilaterals and governments.

Memo
Statement on Money and Finance
I have been asked to identify issues in the area of money and finance that could affect the future stability of the European Union. While there are many important developments in the EU in this field, including new efforts to achieve a single financial market, there is only one area that raises issues that could affect the stability of the EU, and that is the future viability of the European Monetary Union, and its single currency the Euro. While Martin Feldstein may have greatly exaggerated matters in predicting that the failure of the Euro could lead to war in Europe, there is little doubt that the failure of the Euro would create major instability in the EU, and there is a substantial possibility that such instability could lead to the end of the EU itself.
The Euro is a young currency, only having come into full force in 2002. Dissolutions of and exits from currency unions are common. Reuven Glick and Andrew Rose found that from 1948-1997 there were 130 switches out of but only 16 switches into currency unions.1 These findings present no basis for predicting the failure of EMU, but do suggest that the possibility must be taken seriously.
The architects of EMU recognized that there was a danger in constructing a monetary union, with a single monetary policy conducted by European Central Bank (ECB), along side separate fiscal policies conducted by individual Member States. Part of the concern was that irresponsible fiscal policies in particular Member States might create inflationary pressures that would lead the ECB to raise interest rates. Responsible fiscal states would then be forced to bear the higher interest rate costs created by the profligate states. This concern led the architects to impose deficit limitations on countries entering into EMU, and to impose ongoing deficit constraints under the Stability and Growth Pact of 1996 (the Pact). A recent study finds that a large inflation differential between currency union members is consistently associated with a high likelihood of currency union dissolution.2


Under the Pact, any EMU country that runs a fiscal deficit greater than 3 percent of GDP for longer than 10 months has to make a a non-interest bearing deposit with the European Commission. If a country does not remedy the problem within two years, the offending country may have to pay a fine (if voted by two-thirds of the EMU members of the European Council) of at least 0.2 percent of GDP. A country can exceed the 3 percent limit if the excess is “exceptional,” i.e. a result of unusual events outside of control of the Member State and temporary (forecasts indicate the deficit will fall below 3 percent once the exceptional situation passes). While a country with a decline in GDP of over 2 percent within the past four quarters is exempted from the penalties, such persistent and large deficits are uncommon.
The Pact’s constraints have been criticized on the grounds that they impose too rigid constraints on countries wishing to use deficit financing to stimulate economic growth and that adherence to the constraints by a country could cause a political reaction within that country that could undermine the survivability of EMU. Various alternative suggestions have been put forward by scholars, ranging from relaxing the deficit constraints, to fiscal integration, to selling deficit permits. I have seen no suggestion that no EU constraints on deficits are necessary.
Several countries, including France and Germany, have exceeded the 3 percent deficit limit. Indeed, France and Germany are expected to break the Pact’s deficit for a third successive year in 2004. These countries have resisted EU Commission pressures to lower their deficits. In November 2003, the EU finance ministers at the urging of France and Germany, voted to suspend the enforcement of the Pact over the objection of the Commission. In July 2004, the European Court of Justice ruled that the finance ministers had acted illegally, but the Court also stated that it was up to Ecofin as to whether to impose sanctions–which it is unlikely to do given the position of France and Germany.
In September 2004, the Commission proposed a rather vague relaxation of the deficit limitations. The basic idea seems to be that a breach of the 3% limit would not trigger automatic sanctions, but rather the need for a country plan to remedy the deficit. The pace of adjustment could differ across countries, and there would be an increased focus on debt levels rather than deficits. Further, the definition of “exceptional” circumstances could be broadened. These proposals have been criticized by the Bundesbank but the European Central Bank has yet to take any position. France and Germany have criticized the proposals as not relaxing fiscal constraints enough.
The deficit issue also affects the speed at which the 10 new member states can join the EMU, since new entrants must meet convergence criteria, including a 3% deficit limit. It appears several of them do not. The President of the ECB, Jean Claude Trichet, recently stated that it was "absolutely obvious" that a lack of fiscal discipline among the current 12 members of the euro area set a bad example for the 10 countries who joined the EU in May.


As I see it, there is no possibility of returning to hard constraints on deficits, and little hope of any meaningful constraints. Fiscal integration is not a medium term possibility. This then raises the question as to whether a monetary union can function without any real fiscal constraints on members.
One further point. EMU continues to function without the participation of the United Kingdom and there is little prospect that the UK will join in the near term. The decision has been constantly put off into the future. This raises the issue of whether the EU can continue to function on two tracks, some countries with the Euro and others, including a country as important as the U.K, without the Euro.

1 Does a Currency Union Affect Trade? The Time-Series Evidence, 46 European Economic Review 1125 (2002).

2 Volker Nitsch, Have a Break, Have a....National Currency: When Do Monetary Unions Fall Apart?, CESifo Working Paper No. 113 (January 2004).


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