Money, Markets, and Mobility: Celebrating the Ideas of Robert A. Mundell Nobel Laureate in Economic Sciences
Thomas J. Courchene (ed.), 2002 (Paper ISBN: 0-88911-820-5 $22.95) (Cloth ISBN: 0-88911-818-3 $55.00)

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CONTENTS

INTRODUCTION

Robert A. Mundell - Canada's Nobel Laureate

In this volume we honour the magnificent contributions of Robert A. Mundell, arguably the foremost postwar thinker in international macro-economics and the global monetary order. Mundell was not the first Canadian to win a Nobel Prize in Economics and he will not be the last. But his Nobel Prize is surely a quintessentially "Canadian" Nobel Prize in the sense that his intellectual achievements are closely allied with the challenges that Canada, as a small open economy, faces in the global economic order - domestic and external balance, perfect capital mobility, fixed versus flexible exchange rates, optimal currency areas and the like. What Mundell perceived, and what few others did, was that all economies in our progressively global and mobile world would eventually take on the then-distinguishing features of the Canadian economy. Hence, we as Canadians can take special pride in his Nobel Prize since his accomplishments are to an important degree routed in his Canadianness - and this is apart from the fact that he has maintained his close Canadian ties and citizenship.

Queen's University is especially proud of Mundell's achievement as he is a Kingston native. Indeed, this conference celebrates not only Robert Mundell's Nobel Prize but, Queen's conferring on him an Honorary Doctor of Laws.

The role of this introduction is to focus briefly on selected aspects of Bob Mundell's career and, then, to present a brief outline of the volume.

Robert Mundell: A Profile

Robert A. Mundell was born in 1932 in Latimer, Ontario, essentially a crossroads near Loughborough Lake on the outskirts of Kingston. On the occasion of his delivering Queen's School of Policy Studies' inaugural Gibson Lecture in 1990, Bob and his wife Valerie and I finally managed to locate Latimer's abandoned one-room schoolhouse that Mundell asserts was so central to his intellectual formation. In his typically mischievous way, he claims he never really went to grade one: rather, he was able to pick and choose simultaneously from the offering of grades one through eight.

In 1945, the Mundell family moved to Kingston - actually to the Gate House of the Royal Military College since Bob's father was in the army - and Bob took his first year of high school at Kingston Collegiate Vocational Institute. Bob's father retired from the army during this year and the Mundell family moved west to British Columbia, where Bob completed high school and, later, graduated from the University of British Columbia.

He began his graduate work at the University of Washington, then continued at the Massachusetts Institute of Technology (MIT) and the London School of Economics, receiving his PhD in 1956 from MIT. Then began a series of short-term professorships across North America and Europe - to Chicago in 1956-57 as a post-doctoral fellow, then back to UBC for a year and on to Stanford in 1958-59 and the Bologna Institute for Advanced International Studies for 1959-61 before joining the staff of the International Monetary Fund (IMF) in 1961. His time at the LSE introduced him to James Meade and his writings which, combined with his Bologna experience, enabled Mundell to observe first hand both the introduction of the Common Market in 1956 and the Treaty of Rome in 1958, events whose trajectory he would eventually influence as the "intellectual godfather" of the euro. And, of course, his IMF years introduced him to Marcus Fleming, the Deputy Director of the Research Department of the IMF.

By 1963 Bob was back in Canada (McGill) for a year, then off to the Brookings Institution in Washington, DC for 1964-65 and finally to the University of Chicago, where he stayed long enough (1966-71) to develop the what might be termed the Mundell School of "open-economy macro-economics", many of the disciples of which have gone on to achieve renown on their own.

While I am not a Chicago PhD, I did have the incredible good fortune to have been a Chicago post-doctoral student in 1968-69 and to get to know Bob and his work during these creative Chicago years. Chicago's senior faculty were simply grand - among them Friedman, Harberger, Becker, Zellner, Fogel and Coase. International economics was held down by two Canadians: Mundell and Harry Johnson. Harry's lectures were, at one level, a student's delight. The anlytical core of each topic was carefully developed and then all of the relevant recent literature was integrated into this core - a tour de force, to be sure, but one that typically left a student believing that there were precious few loose ends that would provide topics for theses. Bob was exactly the opposite, at least from my limited experience. Mundell would walk into class and present the students with an interesting issue or challenge (sometimes the issue came from the class) and then would proceed to develop a model to tackle it, or at least get the model up and running more or less in the right direction. In the process of this modelling, the air was ripe with thesis topics. Our late Queen's colleague, Doug Purvis, himself a leading Chicago School disciple until his tragic death in 1993, pursued what was likely the optimal strategy - get your ideas from Bob, but write your thesis under Harry!

In 1972, Mundell was again back in Canada, this time as Chair of Waterloo's Economics Department. Finally, in 1974, Bob went to Columbia which, apart from short-term visitorships, has remained his intellectual home to this day. As the Nobel Website notes, these visitorships since moving to Columbia included: the Annenberg Professor of Communications at USC in 1980; the Repap Professor of Economics at McGill in 1989-90; Richard Fox Professor of Economics at the University of Pennsylvania in 1990-91; and a return visit to Bologna in 1997-98. Along the way Bob has received the Guggenheim Prize in 1971, the Jacques Rueff Medal in 1983, the AEA Distinguished Fellow Award in 1997, and he became a Fellow of the America Academy of Arts and Sciences in 1998. Post Nobel Prize, Robert Mundell has received honorary degrees from numerous universities world-wide, including, of course, Queen's University.

While the above Nobel Prize Press Release from The Royal Swedish Academy of Sciences focuses largely on Mundell's contributions from his pre-Columbia period, he has continued to have a remarkably influential career. One of his recent achievements has already been alluded to: his campaign for a single European currency and, more generally, for currency reform in Canada and elsewhere. I need not stress his key and early analytical role in the introduction of the euro. Suffice it to say that although his Nobel Prize was long overdue, it is entirely fitting that Bob won the prize in the year that the euro was inaugurated.

Closer to home, Bob's 1990 paper "The Overvalued Canadian Dollar" represents one of the early contributions in the direction of raising the issue of exchange-rate fixity and monetary union between the United States and Canada. He has followed this with dozens of interviews, articles and public appearances in support of currency consolidation in the Americas.

Among his other recent contributions, the most impressive and most far-reaching would surely have to be his role as the intellectual force behind the "supply-side revolution". This was a natural for Bob in the sense that this was a macro-mix issue. Mundell's recipe, adopted by President Ronald Reagan (with the help of Jack Kemp and others) was that the appropriate macro mix was tight money to control inflation and tax cuts to stimulate growth. It is important to note in this context that the top marginal personal income tax rate in the United States in 1979 was 70%. During the Reagan years, this was reduced to 28% (there is a brief 33% tax rate while the personal exceptions are taxed back). It is also important not to minimize the "demonstration effect" abroad of this U.S. tax cut. Indeed, the sweep of this global revolution is such that I am sure that there is not a single developed country where top marginal tax rates have not been lowered substantially. And Canada is no exception.

While the combination of the Nobel press release and the above review of some of the other major milestones hopefully serves as an appropriate tour d'horizon of Robert Mundell's intellectual career, it nonetheless misses much of what Mundell the person is all about. His interests have always transcended economics. He has always been a keen student of philosophy (how else would we know that Plato was a hard currency advocate, while Aristotle a soft-currency man?). Likewise for history (how else would we know that the looting of Constantinople in 1203 led to the proliferation of fluctuating exchange rates in the middle ages?). Bob is also an accomplished painter. No doubt it was this combination of history and art and philosophy that played a role in his devoting considerable effort over the last 25 years or so to rebuilding and restoring a twelfth-century Medici castle in Tuscany, Santa Columba, more recently called Palazzo Mundell. His Website is liberally sprinkled with pictures of his wife Valerie Natsios and their young son Nicholas, usually with Palazzo Mundell as backdrop.

Mundell remains devilishly young at heart, always good humoured and, as his student Rudi Dornbusch notes, he often comes across as a good natured enfant terrible. Indeed, at the Nobel Prize award ceremony, and again at his Queen's Honorary Degree ceremony, Bob concluded his respective addresses with a rendition of "I Did It My Way".

Outline of Money, Markets and Mobility ...

Beyond the formal recognition of an Honorary Doctor of Laws from Queen's, our way to celebrate Mundell's achievements was to hold a conference in his honour and to publish the Festschrift. An annotated outline of this celebratory volume follows.

Mundell's Nobel Lecture

Thanks to the Nobel Foundation and to Mundell, the volume appropriately begins with Bob's Nobel Prize Lecture. Recognizing that his was the last Nobel Prize in Economics in the twentieth century and with his typical flair for the dramatic, Mundell entitled his lecture A Reconsideration of the Twentieth Century. He divides the century into three distinct and almost equal parts. The first part, 1900-33, is the story of the international gold standard, its breakdown during World War I, its managed restoration in the 1920s and its demise in the early 1930s. The second part, 1934-71, begins with the devaluation of the dollar and the establishment of the $35 gold price and ends when the United States took the dollar off gold. The third part of the century, 1972-99, starts with the move to flexible exchange rates and continues with the subsequent outbreak of massive inflation and stagnation in the 1970s, the blossoming of supply-side economics in the 1980s, and the return to monetary stability and the birth of the euro in the 1990s.

In Mundell's view, the twentieth century ended with an international monetary system inferior to that with which it began. In the penultimate paragraph he elaborates as follows:

Today, the dollar, the euro and yen have established three islands of monetary stability, which is a great improvement over the 1970s and 1980s. There are, however, two pieces of unfinished business. The most important is the dysfunctional volatility of exchange rates that could sour international relations in time of crisis. The other is the absence of an international currency.

Fortunately, in the final paper in the volume, Mundell addresses this "unfinished business".

McKinnon on Optimum Currency Areas

The Nobel Prize Lecture aside, our Mundell Festschrift begins with an analytical focus on optimum currency areas (OCA). The author, Stanford's Ronald McKinnon, is ideally suited to delve into this issue since his own American Economic Review article "Optimum Currency Areas" (September 1963, pp. 717-725) remains a key contribution to the development of the OCA literature. McKinnon's role here is to try to marry the two Mundells, as it were - the Mundell of the seminal 1961 AER paper and the Mundell who later was hailed, as already noted, as the godfather of the euro. As McKinnon emphasizes, the key to bridging these two Mundells lies in two rather obscure articles presented at a 1970 conference in Madrid and published in the conference volume edited by H.G. Johnson and A.K. Swoboda, The Economics of Common Currencies (1973). As McKinnon elaborates, the more analytical of these two articles notes that a country suffering an adverse shock can better share the loss with a trading partner if both countries hold claims on each other's output in a common currency. If, however, a country holds its claims in its own currency and devalues in response to an adverse shock, it then absorbs the loss itself. The more policy oriented of the two is entitled A Plan for a European Currency and it is one of Mundell's first papers arguing for a common European currency. Because Mundell's role in the evolution of the euro is not well known or understood, I have (following Ron McKinnon's suggestion) included A Plan for a European Currency as an Appendix to this volume.

Harris on Open Economy Endogenous Growth

Richard Harris' "The New Economy and the Exchange Rate Regime" is, in an important sense, the most Mundellian of the contributions in this volume. Essentially, Harris takes the endogenous growth model and proceeds to internationalize it in the context of both fixed and flexible exchange-rate regimes. In an economy with two sectors - an old (resource-based) economy and a new (human-capital/information-based) economy - Harris focuses on the implications for productivity under both fixed and flexible rate regimes when the economy is hit by two shocks: a fall in prices in the old economy (e.g., a fall in resource prices) and the advent of a new general purpose technology (GPT) which presents new opportunities for productivity increases. The results of the analysis are striking. If flexible rates are used to buffer (i.e., offset) the fall in commodity/resources prices, productivity falls for two reasons: (i) more labour and capital remains employed in the old, lower productivity economy and (ii) the home country price of the GPT rises in tandem with the depreciating home currency and, therefore, its adoption becomes less pervasive. In contrast, a non-buffered economy (i.e., a fixed-exchange-rate regime) experiences higher productivity in response to the two external shocks because more labour and capital shifts from the old to the new economy and because the GPT is less expensive, both relative to a buffering scenario. In addition to making an important contribution to the optimal currency area debate, Harris' model is likely to trigger a lively literature in the general area of open-economy, endogenous-growth models.

Devereux/Lane on International Macro Simulation

The paper by Michael Devereux and Philip Lane, "Exchange Rate Flexibility and Monetary Policy Choice for Emerging Market Economies", is a convenient bridge between the previous two papers on optimal currency areas and the later session on open-economy macro models. Drawing on one of the results of the Mundell-Fleming model, namely that if the economy is subject to foreign disturbances such as real interest rates or demand shocks, then it is better to let the exchange rate adjust so as to cushion the effect of the shock, Devereux-Lane paramaterize an open-economy model to address the issue of whether developing economies would be better off with fixed or flexible exchange rates in the face of those foreign shocks. The authors compare fixed exchange rates with four variants of flexible rates - a money growth rule, a price stability rate, a Taylor rule (targeting inflation and output) and an optimal policy rule (defined as adjusting either money or interest rates to ensure that the domestic price of non-traded goods equals marginal cost). The conclusions of the simulation suggest that more exchange-rate variability is necessary than is typically allowed within the usual operating rules for monetary policy. The authors recognize that their model ignores shocks emanating from the domestic financial system which, in turn, may place limitations on the ability to conduct monetary targeting as an operating rule. Moreover, the model ignores the reality that developing countries typically cannot issue marketable debt in their own currencies, which also may constrain exchange-rate operations. Nevertheless, as these simulation models embrace more and more characteristics of the real world they will be increasingly able to provide important benchmarking in terms of what to expect from alternative exchange-rate regimes for small, open economies in an integrating global economic order.

Boyer on the Mundell-Fleming Model

Noting that the May 2000 Conference in honour of Mundell was the fortieth anniversary of the origins of the Mundell-Fleming model, Russell Boyer elects to focus his paper on the manner in which the Mundell-Fleming model developed over the 1960-63 period, drawing from Mundell (1960), (1961a), (1961b), Fleming (1962) and, finally, Mundell's classic perfect capital mobility article in 1963. Boyer begins by developing the general framework that underlies both the Mundell and Fleming contributions and presents the implications for the macro mix under both exchange-rate regimes. He then takes us through Mundell's modifications to this basic model - first, shifting the definition of monetary policy from (a) a given level of the money supply to (b) maintaining a constant rate of interest and finally to (c) an open market operation or the change in central bank domestic assets in the context of a definition of money consisting of both foreign and domestic assets and, second and simultaneously, effectively increasing the degree of capital mobility until the familiar FF (external balance) curve becomes horizontal in r-Y space. While the punch line is well known - monetary policy is potent under flexible exchange rates but ineffective under fixed rates (and vice versa for fiscal policy) - the evolution of the model is both instructive and fascinating. As Boyer notes, the elegance and power of the Mundell analysis not only led to its immediate adoption but as well its longevity, ample evidence for which is that "as a device for expounding the effects of macroeconomic policies, the Mundell model diagram is still unsurpassed at the undergraduate textbook level". Boyer adds that this is proof positive of Mundell's dictum - hard writing makes easy reading.

Fortin on the Macro Mix

In 1964, Bob Mundell published "Problems of Monetary and Exchange Rate Management in Canada" in the National Bank Review. This article constituted an assessment of Canadian macro policy in light of Bob's classic papers on monetary and fiscal policies under fixed and fluctuating exchange rates, highlighted in the Boyer paper. Fortin opts to use this same title to direct attention to some key Canadian macro-policy issues in the current time frame. He starts from an intriguing premise. Given that he, along with Mundell and others, believes that a North American Monetary Union is the preferable long-term future for the Canadian currency but is an unacceptable option over the nearer term, the critical policy issue then becomes one of improving the theory and practice of monetary and exchange-rate management. Toward this end, he addresses three broad questions: Has the inflation target been too low? Has actual output tended on average to be too much below potential output? Have monetary conditions become harder to manage? While Fortin answers all three questions in the affirmative, this is vintage Fortin in that much of the richness and insight of the analysis lies in the process of getting to "yes".

Melvin/Waschik on Real Trade and Factor Mobility

In all the excitement about Mundell's contributions to international money and macro policy - optimal currency areas, perfect capital mobility, fixed versus flexible exchange rates, the macro mix, and more recently, the euro and supply-side economics - it is easy to forget that Bob began his career as a trade theorist. James Melvin and Robert Waschik not only remind us of Bob's trade theory work, but they motivate their own contribution "Factor Flows: Immigration in a Specific Factor Framework" by drawing on Mundell's 1957 influential American Economic Review article, "International Trade and Factor Mobility". The starting point of the Melvin-Waschik analysis is Mundell's result that, under certain assumptions, commodity trade and factor mobility are substitutes in the sense that both lead to the same trade equilibrium, namely that all factors will receive the same real incomes. It is also well-known that the so-called specific-factor models represent one case where factor-price equalization will not hold. (The specific-factor model employed by Melvin and Waschik is one where the production of both goods requires labour, but one also requires land while the other also requires capital.) Accordingly, Melvin and Waschik utilize a specific-factor model and explore the extent to which factor prices can differ. The results are quite dramatic. In one of their examples, wages in autarky in the home country are nine times that of the foreign country. However, commodity trade increases the disparity to 11 times! With labour mobility, wages will be equalized - they fall to 23% of autarky levels in the home country and they double in the foreign country. For both countries, a full equilibrium with trade and factor mobility is preferred to migration only. Given that the returns to the specific factors are also affected differentially by trade and by factor mobility, this has the obvious potential for political conflict between labour and the specific factors in terms of how far to pursue trade in goods and/or in factors.

Ostry on the Evolution of the Global Trading Order

No volume focusing on money, markets and mobility would be anywhere near comprehensive without some analysis of the evolution of those supranational institutions primarily responsible for freeing up trade in goods and services. Sylvia Ostry's "Perspectives on the Evolution of the Global Trading System", precisely and ideally fills the bill. Ostry begins by noting that the Uruguay Round and its creation, the World Trade Organization (WTO), embraced a series of "new issues" that have one common factor: they involve not only the border barriers or "shallow integration" of the original General Agreement on Tariffs and Trade (GATT) but, also and primarily, the domestic policy reconciliation or "deeper integration" of the WTO. Phrased differently, the negative integration (the "thou shalt nots") of GATT has given way to the positive integration of the WTO, in effect requiring reconfiguring of domestic infrastructure in terms of governance, legal systems, regulatory systems and the like. Intriguingly, corresponding to the "new issues" are a series of "new players" such as Internet-driven non-governmental organizations (NGOs). Accordingly, and appropriately, a major part of Ostry's analysis is devoted to elaborating on the three broad roles for, or types of, NGOs: "mobilization networks" whose chief objective is to rally support for a specific set of activities; "technical networks" designed to provide specific information related to WTO issues; and a "virtual-secretariat" role to inform and to assist developing countries in their WTO relationships. Thus, further progress in freeing international trade in goods and services requires directing attention to both institutional/structural issues and to policy issues. Sylvia Ostry opts more for the latter when she concludes that where there is a political will there is a policy way, which she hopes will soon lead to a serious rethinking of global policy.

McCallum, Grubel and von Furstenberg on Common Currencies

Setting aside the Nobel Prize Lecture, the volume began with some analytical perspectives relating to optimal currency areas and currency consolidation. The two concluding sections return to this theme, the first of which is in the form of a policy roundtable focusing on the pros and cons of a North American common currency.

John McCallum (then with the Royal Bank, now the Secretary of State for International Financial Institutions) opens the roundtable with "Engaging the Debate: Costs and Benefits of a North American Common Currency". For McCallum, a North American common currency means either dollarization or a currency board: he rejects any option based on a North American version of the euro. After he further rejects dollarization as politically unacceptable and a currency board as a slippery slope toward dollarization, McCallum is left with flexible rates, and the core of his contribution is basically a defence of the floating-rate status quo on grounds of sovereignty and policy flexibility, on the one hand, and a dismissal of the common currency arguments that flexible rates have undermined living standards and reduced Canadian productivity relative to the United States, on the other.

Herbert Grubel is one of the most ardent proponents of Canada-U.S. currency integration. In his paper, "Toward North American Monetary Union", Grubel focuses on some of the new and/or lower profile rationales for monetary union (implicitly directing the reader to his 1999 Fraser Institute publication for more mainstream rationales). One of his principal arguments is that the degree of labour-market flexibility and the nature of adjustment mechanisms are not independent of the exchange-rate regime. Specifically, Grubel argues that the removal of the exchange rate as a shock absorber would lead to much enhanced labour-market and institutional flexibility: indeed the famous European Commission report, One Market, One Money argued that monetary union would enhance labour market flexibility. The upshot of all of this, according to Grubel, is that those empirical studies that suggest that shocks are difficult to accommodate under fixed exchange rates must be seriously discounted if the data they rely on were generated under flexible rates. As a concluding comment, Grubel notes that the wholesale acceptance of the Keynesian assumption of downward rigid wages led to inflation and deficits as solutions to unemployment. Now that price stability and balanced budgets have triumphed over inflation and deficit financing, attention has turned to the importance of flexible rates to deal with unemployment and imperfect labour market flexibility. Grubel's parting shot is that the time has come for exchange-rate flexibility to join inflation and deficits on the scrap heap of policies inspired by Keynesian economics.

In "Unilateral and Multilateral Currency Integration: Reflections on Western Hemispheric Monetary Union", George von Furstenberg broadens the discussion beyond a Canada-U.S. currency union. His view is that while dollarization may be a useful immediate option for some countries in our hemisphere, it is a second-best option in the short run and unsustainable in the long run. This long-run unsustainability will arise because if the option of monetary union is not available, then rather than losing seigniorage indefinitely countries will, in tandem, reclaim co-ownership and co-management of their monetary assets in a multilateral monetary union with like-minded countries. The Americans could attempt to counter this somewhat by making dollarization more attractive, for example, by returning some of the seigniorage to the dollarizing country. But even this will unlikely be enough. Von Furstenberg concludes that eventually dollarization (or unilateral monetary union as he calls it) will be doomed and destabilizing unless it evolves toward a multilateral form from within. Hence, his policy recommendation is that it is time for the United States to take a careful look at Europe's multilateral model of monetary union and to develop a variant that could become beneficial for the western hemisphere as a whole.

Mundell on Currency Evolution

It is entirely fitting that Bob Mundell has the last word, specifically "Exchange Rate Systems and Currency Integration: Prospects for the Twenty-First Century". This paper fulfills two roles. Firstly, it is a natural extension and elaboration of the series of issues dealt with by McCallum, Grubel and von Furstenberg. Secondly, it is a perfect "bookend" to Mundell's Nobel Lecture. The latter paper (and century) essentially ends with the introduction of the euro in 1999 whereas this paper begins with the advent of the euro and what this might augur for the twenty-first century. The analysis is far reaching, focusing as it does on alternative approaches to currency integration, on alternative approaches to monetary rules, on the pros and cons of dollarization and its alternatives from a Canadian perspective, on the need for both external and internal stability and, finally, on the advantages of a world currency. His concluding paragraph is instructive:

The link between language and currency has often been noted. Language is a medium of communication and currency is a medium of exchange. National, ethnic and liturgical languages are here to stay, but a common world language, understood as a second language everywhere, would obviously facilitate international understanding. By the same token, national or regional currencies will be with us for a long time in the next centuries, but a common world currency, understood as the second most important currency in every country, in which values could be com-municated and payments made everywhere, would be a magnificent step toward increased prosperity and improved international organization.

* * *

All that remains is for me to express my sincerest thanks, as well as those of the John Deutsch Institute for the Study of Economic Policy and our co-sponsors in this venture, to the authors and to Robert Mundell for their contributions to this volume.

It is a privilege and an enormous pleasure for me to invite you to sample our celebratory tribute to Robert Alexander Mundell, the 1999 Nobel Laureate in Economic Sciences.

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©2002 John Deutsch Institute, Queen's University