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«Munich Discussion Paper No. 2001-4 Department of Economics University of Munich Volkswirtschaftliche Fakultät Ludwig-Maximilians-Universität ...»

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Holger Feist:

The Enlargement of the European Union and the

Redistribution of Seigniorage Wealth

Munich Discussion Paper No. 2001-4

Department of Economics

University of Munich

Volkswirtschaftliche Fakultät

Ludwig-Maximilians-Universität München

Online at http://epub.ub.uni-muenchen.de/16/

The Enlargement of the European Union

and the Redistribution of Seigniorage Wealth


Princeton University and CESifo


In the course of the EU enlargement process, the participation of accession countries in the European Monetary Union might lead to a significant redistribution of seigniorage wealth if current regulations prevail. In general, accession countries will be winners from this redistribution, for example Poland with 12.9 billion euros, Romania with 9.9 billion euros or Hungary with 3.3 billion euros. Correspondingly, the current member countries of the European Union face costs of 35.3 billion euros in total, the biggest part of which has to be borne by Germany.

Keywords: European Currency Union, Transition Economies, European Integration, Central Banks, Seigniorage JEL Code: E 58, F33, P33 ∗ Address: Holger Feist, Princeton University, 448 Robertson Hall, Princeton NJ 08540-1013 (U.S.A.), E-Mail: hfeist@wws.princeton.edu, Web: www.princeton.edu/~hfeist.

–1– The Enlargement of the European Union and the Redistribution of Seigniorage Wealth


1 Introduction The enlargement of the European Union (EU), primarily to countries which are still in a process of transition from planned to market economies, is one of the greatest endeavors the continent has ever undertaken. Currently, the EU commission officially recognizes 13 countries in central and eastern Europe as candidates for accession. Twelve of them have started their formal accession negotiations, namely Bulgaria, Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Romania, the Slovak Republic and Slovenia. The present paper focuses on these twelve countries which have already met the Copenhagen criteria, a prerequisite to becoming EU members.1 Currently, these countries are running a well-defined pre-accession program, while the EU carries out institutional reforms necessary to be in a position to accept the new member states as from 2003 on.

Turkey, also an official candidate for accession since the Helsinki European Council on 10 and 11 December 1999, still has to meet the conditions to be fulfilled before negotiations will be taken up.As laid down at the Copenhagen European Council in June 1993, these criteria require: a.) the stability of institutions guaranteeing democracy, the rule of law, human rights, and the respect for and protection of minorities; b.) the existence of a functioning market economy as well as the capacity to cope with competitive pressure and market forces within the EU; and c.) the ability to take on the obligations of membership, including adherence to the aims of political unification, as well as economic and monetary union (cf. European Union, 1999, p. 2).

–2– In the monetary field, it is clear from the Copenhagen criteria that adherence to the aim of European Monetary Union (EMU) is one of the duties involved in the membership process. There will be no opt-out clauses for the new members, as there were for the United Kingdom and for Denmark when EMU was first created. Becoming an EU member automatically implies a commitment to finally adopting the Euro.

Accession countries will initially participate in EMU with the status of a member state with a derogation, but they will have to prepare themselves for full participation. These efforts toward convergence will be assessed at least once every two years, and a country will finally become a full member of the EMU and adopt the Euro as its currency. 2 The economics literature guides this process mainly by concentrating on issues of central bank independence (see, for instance, Radzyner and Riesinger, 1997, Wagner, 1999, or Cukierman, Miller and Neyapti, 2000) or in analyzing the implications of the Euro for the transition process of the economies (see Koehler and Wes, 1999).

However, full membership in EMU involves one further issue, which is both crucial and often neglected. As a matter of fact, monetary union is not only about the quality of the common currency, about money supply and price stability. It is also about sharing seigniorage profits. Central banks earn interest by lending their money to the private sector at the market rate. In doing so over a long period of time, they have steadily been accumulating interest-bearing assets while expanding their respective monetary base. These assets are now stocks of historic seignorage wealth, generating a constant annual stream of returns that helps finance government budgets. With the original creation of EMU, seigniorage wealth was redistributed between original member countries. This redistribution was noted by Remsperger (1996), and then studied

–  –  –

extensively by Sinn and Feist (1997, 2000) as well as by Gros (1998). With EU enlargement, a further round of seigniorage redistribution will begin. On the one hand, present non-member countries will have to give up their national seigniorage wealth with their accession to EMU to be socialized among all member countries. On the other hand, these countries will receive a well-defined share of the common pool.

Once this problem is clearly laid out in the following section, the obvious question is easily seen: who will win and who will lose from the redistribution of seigniorage wealth through EU enlargement? The answer will be provided in two steps, taking first the perspective of the new member countries, then focussing on current EMU member states. In both cases, actual gains and losses will be calculated. Since in effect, the overall outcome will result in a huge net wealth transfer from the old to the new member countries, the concluding remarks in the last section question whether this amount of redistribution is intended by government officials, and if not, how it could be avoided. But for now, back to a more specific definition of the problem.

2 Seigniorage Wealth and Seigniorage Redistribution The theoretical concept of seigniorage wealth is discussed at length in Sinn and Feist (2000), but its core is based on a simple idea. A central bank essentially makes profits because it is entitled to provide the private sector with legal tender. While the assets obtained in exchange for it are interest-bearing, the central bank does not pay interest on the currency it issued. 3 This discrepancy results in a flow of central bank profits which helps the government to finance its budget year after year. If a nation decides whether or

–  –  –

not to join a monetary union, hence to give up its monetary authority, it also foregoes this entire flow. By definition, the present value of this profit flow is equal to the market value of assets held by the central bank as a counterposition to its currency. Therefore, in economic terms it is justifiable to regard the waiving of the profit flow due to monetary union as foregoing the assets backing the currency circulation. These assets are a new member country’s contribution to the common pool of seigniorage wealth.4 The overall effect of full EU enlargement would be an increase in seigniorage wealth from 406.8 billion euros to 429.3 billion euros, representing a 5.5% growth.

Contributions of individual countries differ, of course, as can be seen in Figure 1 which shows how much national currency is currently being used, and therefore how much seigniorage wealth is being transferred to the common pool.

In a legal sense, only the future interest income generated by seigniorage wealth will be pooled within the Eurosystem, and the national central banks will remain the legal owners of the assets backing the monetary base. However, from an economic point of view, the socialization of an asset’s return is the same as the socialization of the asset itself (see the detailed discussion in Sinn and Feist, 2000).


–  –  –

Figure 1: Currency in Accession Countries. Notes: Billions of euros, data as of 31 December 1998. BG – Bulgaria, CY – Cyprus, CZ – Czech Republic, EE – Estonia, HU – Hungary, LV – Latvia, LT –

Lithuania, MT – Malta, PL – Poland, RO – Romania, SK –Slovak Republic, SI – Slovenia. Source:

International Monetary Fund (2000), International Financial Statistics, March, Washington, D.C.

Poland, which is also the largest country, contributes most with 8.6 billion euros, followed by the Czech Republic with 4.3 billion euros and Hungary with 2.4 billion euros. To provide a better understanding of these numbers, the black shadows of the bars state a fictitious amount of currency which would circulate in the country if it used just as much money per unit of GDP as the EU countries do on average. Obviously, in most countries there is more currency in circulation than there were in western-type economies with the same gross domestic product, and the numbers prove this visual inspection to be true. While in the EU, 5.4 euros are in circulation on average per hundred euros of gross domestic product, the average of all accession countries is 5.9 per cent.

Of course, contributing national seigniorage wealth which stems from the currency is only one side of the coin for a country. For these contributions, each country in turn earns a share of the common profit flow resulting from the pooled assets. This

–  –  –

that these two shares do not match one another, seigniorage wealth is redistributed. In general, there will be a difference because according to the Statute of the European System of Central Banks and the European Central Bank (ECB), what a country receives from the pool is not determined by its amount of currency, but rather by its capital share in the ECB. 5 The capital share is in turn determined by the average of a country’s shares in EU aggregate population and gross domestic product, a combination index that might serve as an idiosyncratic single measure of country size. Figure 2 provides an illustration of what individual countries receive and what they contribute.

–  –  –

Figure 2: Seigniorage Wealth and Country Size. Notes: Billions of euros, data as of 31 December 1998.

BG – Bulgaria, CY – Cyprus, EE – Estonia, LV – Latvia, LT – Lithuania, MT – Malta, SK –Slovak Republic, SI – Slovenia. Source: International Monetary Fund (2000), International Financial Statistics, March, Washington, D.C.

The initial endowment of ECB equity capital has little function other than to establish a stake in the seigniorage profit. With just 5 billion the total capital endowment is tiny relative to seigniorage wealth.

Furthermore, the interest it generates will be distributed among the members of the Eurosystem in proportion to the capital contribution, so that no redistribution will take place here.

–7– The seigniorage wealth each country contributes is noted on the horizontal axis and the country size, which determines what they receive, on the vertical axis. Therefore, countries located in the upper left of this diagram win from the distribution, while countries located in the shaded triangle in the lower right lose. It turns out that most of the countries considered as candidates for EU enlargement win. Only Cyprus and Malta lose, but their proximity to the origin of the diagram indicates that both their contributions and their receipts are relatively small.

The following sections explore in greater detail how much is at stake for indivdiual countries. First, a calculation of precisely how much the accession countries will actually earn from the redistribution of seigniorage wealth is made. Then, the loss of individual EU countries is calculated.

3 Redistributive Effects for the Economies in Transition As shown in the previous section, distributing the pooled seigniorage wealth according to a key other than that measuring the individual contributions of the participating countries permits some countries to win, while others lose. Now that the mechanism of redistribution has been properly discussed, the amount of this redistribution may be calculated. In the following, the situation is presented from the perspective of the accession countries. Section 4 will then highlight the point of view of current member countries.

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