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Is the Fed Being Swept Out of (Monetary) Control?

Jeffrey M. Wrase

Is the Fed Being Swept
Out of (Monetary) Control?
Jeffrey M. Wrase*

W

hat has your bank done for you lately?
One task your bank has probably carried out is
settling checks you’ve written and payments
you’ve made with your debit card. Settling
transactions is an important function of banks.
Most of us would be upset if we received a notice from a bank informing us that it is temporarily out of funds and must wait before it pays
the recipients of checks we’ve written. However, we are spared this upset because banks
hold reserves to guard against such events. But
settling payments isn’t the only reason banks
hold reserves: they’re required to do so by law.

*Jeff Wrase is a senior economist in the Research Department of the Philadelphia Fed.

For many banks, required reserves have been
larger than what they needed to settle payments. And because the Federal Reserve cannot, by law, pay interest on reserves, banks can’t
earn money on them. In response, banks have
set up “sweep accounts”: a bank “sweeps”
funds out of traditional checking accounts,
which are subject to reserve requirements, and
into money market deposit accounts, which are
exempt from reserve requirements.1

1
In this article, the word bank refers to depository institutions required to hold reserves. These institutions, according to the Monetary Control Act of 1980, include commercial banks, mutual savings banks, savings and loan associations, credit unions, agencies and branches of foreign
banks, and Edge Act corporations.

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BUSINESS REVIEW

Although sweep accounts benefit banks by
reducing the amount of non-interest-bearing reserves they have to hold, such accounts complicate the Federal Reserve’s job of implementing monetary policy. As sweep accounts reduce
reserves toward the levels needed solely to
settle payments, banks more often scramble to
borrow and lend reserves, also called federal
funds, in response to unforeseen deficiencies
and surpluses. As a result, the federal funds
rate—the short-term interest rate at which
banks borrow and lend reserves among themselves—could become more and more volatile.
In this article, we will consider what effects
sweep accounts have had on the market for
bank reserves and on the Federal Reserve’s job
of managing reserves in the banking system.2
We’ll also look at a recent change the Federal
Reserve has made to prevent interest rate volatility from increasing as use of sweep accounts
continues to spread.
WHAT ARE RESERVES, AND
WHY DO BANKS HOLD THEM?
A bank’s reserve balance is simply an
amount that it holds as cash in its vault or on
deposit at the Federal Reserve. Currently, depository institutions in the United States are
legally required to hold some reserves against
transaction deposits, such as checking accounts.3 Even if they weren’t required to, banks
would still hold some reserves to settle transactions.
For example, your bank uses its account at a
Federal Reserve Bank to transfer funds to other

2
For a more detailed examination of these issues, see
the article by Cheryl Edwards.
3
Reserve requirements have been imposed primarily on
transaction deposits, a practice reflecting earlier attempts
by the Federal Reserve to use reserve requirements to help
target some measure of the money supply. For further discussion of historic rationales for reserve requirements, see
Joshua Feinman’s article.

4

NOVEMBER/DECEMBER 1998

banks to settle checks you wrote or electronic
transfers you made. It also uses its reserve account to accept funds from other banks to settle
checks or transfers made to you by others.
When a bank sends payments on behalf of its
customers, the Federal Reserve debits the
bank’s reserve account, and its reserve balance
goes down. When a bank receives payment, the
Fed credits the bank’s reserve account, and its
reserve balance goes up.
Payment inflows and outflows occur
throughout each business day and immediately
show up in banks’ reserve accounts. To ensure a
smoothly functioning payment system, the Federal Reserve allows banks to have overdrafts in
their reserve accounts during the day, but the
overdrafts are monitored, and these daylight
overdrafts are expected to be repaid in full by the
end of the day.4 The Fed charges a small fee for
daylight overdrafts and a large fee for overdrafts
that persist after the 6:30 pm close of business.5
Sometimes banks hold excess reserves, reserves in amounts above the required minimum. Excess reserves guard against unexpected payment outflows that could drain reserves below the required level and lead to an
overdraft penalty. But there is a cost to holding
excess reserves: a bank could have earned interest by lending or investing those funds. Similarly, required reserves, which bankers sometimes call idle or sterile balances, cannot be used
to make loans and earn interest. To minimize
the loss of interest, banks have reduced reserves
by improving reserve management and, more
recently, by creating or expanding sweep accounts.

4
For a discussion of daylight overdrafts, see the article
by Heidi Richards.
5
The daily volume of payments sent and received is
large—nearly $2 trillion. Craig Furfine’s article points out
that banks that are active in the payment system typically
send and receive payments whose value is around 30 times
the bank’s overnight reserve balance.

FEDERAL RESERVE BANK OF PHILADELPHIA

Is the Fed Being Swept Out of (Monetary) Control?

Jeffrey M. Wrase

balances, which it can then use to earn interest.
HOW DOES A SWEEP ACCOUNT WORK?
Most checking deposits held at banks at the In exchange, the bank may pay you interest or
close of a business day are subject to a 10 per- reduce its fees for bank services.8
cent reserve requirement, but money market
As noted earlier, sweep accounts have exdeposit accounts have no such requirement.6 A panded since 1995. The cumulative amount of
sweep account takes advantage of this differ- sweeps from the beginning of 1995 through July
ence—the bank temporarily transfers funds from 1998 has been estimated at nearly $300 billion
reservable checking deposits into nonreservable (Figure 1). The resulting drop in checking acmoney market deposit accounts.
Consider how a sweep account could work
8
for you. Your bank would set up two separate
Some programs sweep out balances over weekends;
sub-accounts: one would be a checking account others regularly sweep out all balances above a predetersubject to reserve requirements, and the other mined target. Regulations limit the number of automatic
transfers from an MMDA to six per month; therefore, upon
would be a money market deposit account the sixth transfer, all the remaining funds in your MMDA
(MMDA) not subject to reserve requirements. are swept back into your checking account.
Each month, if your checking
balance exceeded some speciFIGURE 1
fied maximum, your bank
Sweeps of Transaction Deposits into MMDAs
would sweep the excess into
Monthly Averages of Initial Amounts
the money market account.
Later, if your checking balance
fell below some preset minimum, your bank would transfer funds from your money
market fund back to your
checking account.7 The bank
benefits because sweep accounts free required reserve
6
Since January 1998, for example,
each bank must meet a reserve requirement of 3 percent applied to net
transaction accounts totaling between
$4.7 and $47.8 million; the 10 percent
rate applies to net transaction accounts above $47.8 million. For a detailed description of reserve requirements, see Ann-Marie Meulendyke’s
book.
7
Households have only recently
been offered the option of sweep accounts, a financial innovation that
became widespread for business accounts in the mid-1970s. The advent
of enhanced computer technology
and software has enabled banks to
sweep household as well as business
accounts.

Sweeps of Transaction Deposits into MMDAs
Cumulative Total

Source: Federal Reserve Board of Governors

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NOVEMBER/DECEMBER 1998

count balances was partly offset by strong economic growth, which increased the need for
transaction balances. On net, checking account
balances declined $174 billion. Required reserves fell $16 billion as a result, to around $43
billion, between January 1995 and July 1998
(Figure 2). While the ultimate effects of sweeps
on reserve holdings are uncertain, such programs could reduce the levels of required reserves 50 percent or more from their level in 1994,
according to an estimate made by the Federal
Reserve Bank of St. Louis.9
Over the past few years, a closely watched
issue has been whether the proliferation of
sweep accounts, and the coincident reductions
in reserves in the banking system, would increase the variability of the federal funds rate.
To examine this issue, we need to consider how
banks respond when confronted with a deficiency or surplus of reserves and how shortterm interest rates are related to banks’ reserve
balances.
THE MARKET FOR RESERVES:
THE FEDERAL FUNDS MARKET
A bank accumulates reserves from customers’ cash deposits and payments from other
9

See Richard Anderson’s article.

FIGURE 2

Required Reserves

Source: Federal Reserve Board of Governors
6

banks and loses them to customers’ withdrawals and payments to other banks. Therefore, a
bank’s reserve level fluctuates.
If outflows push reserves below a desired
level, a bank can acquire more in several ways:
It can issue certificates of deposit; it can sell a
liquid asset, such as a Treasury security; it can
borrow directly from the Federal Reserve at the
Fed’s discount window; or it can borrow reserves in the federal funds market.10 If a bank
has excess reserves, it can purchase a liquid asset, make a loan to a business or household, or
lend reserves to another bank in the federal
funds market. In the federal funds market, supply and demand interact to determine the quantity of reserves that banks borrow and lend as
well as the federal funds rate at which they borrow and lend.
A bank that ends the day with excess reserves
is less likely to borrow and more likely to lend
in the federal funds market, usually overnight.
A bank that ends up with deficient reserves can
avoid an overnight overdraft penalty by borrowing in the federal funds market. So banks’
daily demands for reserves in the federal funds
market depend on banks’ daily payments activity. Hence, there is a close link between payments activity, banks’ daily reserve demands,
and daily movements in the federal funds rate.11
10

If a bank chooses to borrow at
the Fed’s discount window, it must
post acceptable collateral, such as a
U.S. Treasury security. While the discount rate is typically below the federal funds rate, thereby providing an
incentive to borrow from the discount
window, discount-window borrowing is to be used only when the bank
cannot reasonably obtain funds from
other sources to compensate for unusual and unforeseen reserve losses.
The Fed administers discount lending
in a fashion that discourages banks
from frequently asking for discountwindow loans of reserves.
11
For evidence of such a link, see
the article by Craig Furfine.

FEDERAL RESERVE BANK OF PHILADELPHIA

Is the Fed Being Swept Out of (Monetary) Control?

If payments activity becomes volatile, so, too, can
banks’ demands for reserves and the federal
funds rate.
In the face of fluctuations in reserve demands, the Federal Reserve plays an important
role by managing the supply of reserves in the
banking system.
HOW DOES THE FED
MANAGE RESERVES?
The Federal Reserve manages the supply of
reserves through the purchase and sale of government securities. When the Fed buys securities, it increases the supply of reserves; when it
sells securities, the supply of reserves shrinks.

Jeffrey M. Wrase

(See Open Market Operations.) The objective is to
engineer a supply of reserves that achieves a federal funds rate equal or close to a target determined by the Federal Open Market Committee
(FOMC). The target for the federal funds rate depends on the state of the economy and, of course,
reflects the Federal Reserve’s policy goals of a
stable price level and maximum sustainable
employment and economic growth.
In practice, staff of the Open Market Desk at
the Federal Reserve Bank of New York and staff
at the Board of Governors in Washington, D.C.,
generate daily forecasts of reserve demand and
of factors affecting the supply of reserves. On
the basis of the forecasts, the Desk engages in

Open Market Operations
The Open Market Desk uses open market operations—the sale and purchase of previously issued
government securities—to exercise monetary control. In general, when the Desk sells securities to a
dealer, the dealer’s payment reduces the amount of reserves in the banking system. Conversely,
when the Desk purchases securities from a dealer, the Fed pays for them by crediting the reserve
account of the dealer’s bank at a Federal Reserve Bank, which increases the amount of reserves in the
banking system. The Desk engages in two types of transactions to extract or inject reserves: one,
outright purchases and sales of securities and, two, repurchase agreements.
Outright Purchases and Sales
The Desk uses outright purchases and sales to effect long-term changes in the supply of reserves.
Outright purchases and sales are conducted infrequently.
Repurchase Agreements (Repos) and Matched Sale-Purchase (MSP) Transactions
Most influences on the reserve market are short term, so the Desk uses repos to inject reserves into
the banking system on a short-term basis and MSPs to extract reserves temporarily. “Short term” and
“temporarily” mean one to a few days. Repos and MSPs are the tools the Desk uses most frequently.
Repos. In a repurchase agreement, the Desk purchases securities from dealers who agree to repurchase them at a specified price and date. When the Desk purchases the security, it adds reserves to the
banking system. Then, when the repo matures, the initial injection of reserves is reversed. This is a
convenient way for the Desk to deal with short-term changes in reserve-market conditions, since
transaction costs for repos are low.
MSPs. Matched sale-purchase transactions (also known as reverse repos) are used to temporarily
extract reserves from the banking system. In an MSP transaction, the Desk contracts to sell securities
to a dealer and matches that trade with a contract to purchase the securities back from the dealer at a
specified price and date. The Desk’s initial sale of securities reduces the amount of reserves in the
banking system, while its subsequent repurchase returns those reserves to the banking system. MSPs,
like repos, are very short term in nature.

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NOVEMBER/DECEMBER 1998

transactions to generate a supply of reserves intended to produce the FOMC’s desired federal
funds rate.12
HAS THE OPEN MARKET DESK
BEEN SWEPT OUT OF CONTROL?
Because they’ve been using sweep accounts
to reduce their required reserves, many banks
now meet their reserve requirements with vault
cash alone. Such banks hold reserve deposits
mostly to settle payments between their customers and others rather than to meet reserve
requirements. Because banks’ demand for reserves to settle payments varies more than demand for reserves to meet requirements, it has
become harder for the Desk to forecast reserve
demand, which means the Desk has more difficulty hitting a specific federal funds rate. In
this respect, the spread of sweep accounts has
much the same effect as would a cut in the 10
percent reserve requirement.
12
Additional details of the Desk’s activities can be found
in the book by Ann-Marie Meulendyke or Marcia Stigum.

Consider the behavior of the federal funds
rate following reductions in required reserves
at the end of 1990 and again in April 1992 (Figure 3).13 Beginning in December 1990, and for
the first few months in 1991, the range of the
fed funds rate was very wide. However, such
large swings did not follow the reductions in
reserve requirements in April 1992, perhaps
because banks and the Desk had learned from
the earlier episode how to better manage reserves in a system with lower requirements.
Similarly, after the use of sweep accounts expanded in mid 1995, the federal funds rate became more variable, but not much (Figure 3).
Even if the expansion of sweep account programs adds substantially to the variability of
the federal funds rate, are day-to-day or intraday movements in such a short-term interest
rate cause for concern? There are a couple of
13
In December 1990 the Fed eliminated all reserve requirements on savings (time) deposits and on
Eurocurrency liabilities. In April 1992, it lowered the requirement on transaction deposits from 12 percent to 10
percent.

FIGURE 3

Federal Funds Rate: Intraday Range
Monthly Average of Daily High Minus Daily Low
April 1988 - April 1998

Source: Federal Reserve Board of Governors
8

FEDERAL RESERVE BANK OF PHILADELPHIA

Is the Fed Being Swept Out of (Monetary) Control?

reasons we might be concerned about increased
variability of very short-term interest rates.
One, it becomes more difficult for the Federal
Reserve to hit its target for the federal funds
rate in an environment with greater variability
in banks’ reserve demands. As a result, the
funds rate will deviate more often from the
Fed’s targeted rate, which may make it more
difficult for market participants to gauge the
course of monetary policy the Fed wants to take.
While the federal funds rate does sometimes
deviate from the FOMC’s target, the Federal
Reserve has not faced great difficulty hitting
its target, on average, in recent years. Nor is
there evidence that sweep accounts have
clouded perceptions about the course of monetary policy. Two, increased variability of shortterm interest rates may be transmitted to longterm interest rates, and increased variability in
long-term interest rates might cause greater
variability in expenditures by households and
firms in the economy. However, there is no evidence that more variable short-term interest
rates have led to substantially more variable
long-term rates in recent years. Nonetheless, the
possibility that interest rates might become still
more variable as sweep accounts continued to
spread led the Federal Reserve to examine ways
to reduce potentially deleterious volatility in
the federal funds rate.
WHAT DID THE FED DO
TO KEEP VARIABILITY IN CHECK?
The Federal Reserve had several options to
help reduce day-to-day variability in the federal funds rate. (See Options for Maintaining
Monetary Control in a World of ShrinkingReserves.)
It chose a simple one: changing the period over
which banks calculate their required reserves.
To explore why the switch in timing reduces
variation in banks’ reserve demand, and
thereby makes the job of monetary control
easier, let’s see how banks calculate required
reserves.
Each bank calculates required reserves on its

Jeffrey M. Wrase

average amount of transaction deposits over
two weeks, called the reserve computation period.14 To satisfy its reserve requirement, a bank
can use two balances. One balance is the average level of reserve deposits held at a Federal
Reserve bank during a two-week span called
the reserve maintenance period; the other is the
amount of vault cash the bank held during an
earlier period.15 Averaging over two-week periods, rather than making banks calculate and
meet reserve requirements each day, helps reduce day-to-day volatility in the federal funds
rate.
Prior to July 1998 the two-week reserve
maintenance period was nearly contemporaneous with the reserve computation period. The
computation period ended every other Monday; the maintenance period ended two days
later. One problem with this so-called contemporaneous reserve accounting method was that banks
didn’t know their reserve requirement for sure
until two days before the end of the reserve maintenance period. Banks that found themselves
short of their reserve requirement on the last two
days of the maintenance period scrambled to
obtain reserves in the federal funds market. Because the Open Market Desk didn’t know, and
couldn’t always forecast, how big banks’ shortages of reserves would be, last-minute surges in
the demand for reserves sometimes caused
spikes in the federal funds rate.
Under contemporaneous reserve accounting,
sweep accounts made it even harder for banks,
as well as the Federal Reserve, to accurately es14
To arrive at a bank’s reserve requirement, the end-ofday balances of a bank’s transaction accounts for each day
of the computation period are averaged, and this average
daily balance is multiplied by the appropriate required-reserve percentage.
15
Technically there are some other balances that count.
Banks are permitted, for example, to carry a surplus or deficit from one maintenance period to the next. The carryover
cannot, however, be bigger than a specified fraction of required reserves and must be applied in the next maintenance period.

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BUSINESS REVIEW

NOVEMBER/DECEMBER 1998

Options for Maintaining Monetary Control in a World of
Shrinking Reserves
Under the Federal Reserve’s current operating procedures, monetary control is exercised by targeting a level of the federal funds rate. As we saw in the discussion of the federal funds market in the
text, the federal funds rate is determined by the interaction between the demand for and supply of
reserve deposits. To reduce the volatility of the federal funds rate, the Federal Reserve has many
options. Some options make the demand for reserves less variable; some make the supply of reserves more responsive to variations in the demand for reserves.
Making Demand for Reserves Less Variable
One way to make the demand for reserves less variable is to extend reserve requirements to more
accounts. The Federal Reserve’s authority to alter reserves and its ability to impose reserve requirements on nonchecking deposits are set out in the Monetary Control Act of 1980 and the Garn-St.
Germain Depository Institutions Act of 1982. If reserve requirements are expanded to include more
accounts, moving deposits from one kind of account to another will have less effect on required
reserves, thus making the aggregate demand for reserves more predictable. If predictability of reserve demand were the objective, expanding requirements might be a solution. However, expanding reserve requirements would lead to even more idle, non-interest-bearing balances in the banking system, and banks would undoubtedly also continue to devote resources to coming up with
innovations designed to evade requirements.
A second option would be to eliminate reserve requirements completely, pay interest on any
excess settlement balances, and charge a penalty on deficient ones. In principle, the interest and
penalty payments can be structured to provide incentives for banks to target positive, negative, or
zero settlement balances. The Bank of Canada, for example, provides incentives for zero settlement
balances; hence, on average, Canadian banks should have no idle reserves. This option also removes
incentives to expend resources to evade reserve requirements and leads to a predictable demand for
reserves.
A third option is to keep reserve requirements but pay interest on reserve balances. Paying interest would remove the incentive for banks to evade reserve requirements and thereby lead to a more
stable demand for reserves. But paying interest would also increase the Federal Reserve’s expenditures, and, consequently, the Fed would have a lower surplus to return to the Treasury. Because of
this, the Treasury has not supported recent or past proposals to pay interest on reserves.

timate reserve needs as reserve demands increasingly reflected payments activity. The relatively
more volatile payment-related demands for reserves began to dominate demands to meet reserve requirements. As a result, more unforeseen
changes in banks’ demand for reserves occurred.
Such volatility in demand led to increased variability of the funds rate as sweep activity continued.
To reduce the variability of the funds rate,
the Fed switched to lagged reserve accounting.
Two-week reserve computation periods still
10

end every second Monday. But effective July 30,
1998, a bank bases its required reserves for a
maintenance period on its average deposits in
the reserve computation period that ended two
weeks plus two days before the maintenance
period begins. Under this regime, banks know
exactly what their reserve requirement is at the
beginning of each maintenance period and how
much of the requirement has already been met
with vault cash. The Open Market Desk also
knows exactly the amount of reserves that must
be held, on average, during each two-week mainFEDERAL RESERVE BANK OF PHILADELPHIA

Is the Fed Being Swept Out of (Monetary) Control?

Jeffrey M. Wrase

On July 23, 1997, Federal Reserve Board Chairman Alan Greenspan urged Congress to remove the
ban that prohibits the Federal Reserve from paying interest on banks’ reserve balances. The Fed chairman also suggested a more fundamental change—eliminating reserve requirements altogether. He
added that “it might well require significant adjustments in the implementation of monetary policy,
including adoption of procedures to control volatility in overnight interest rates that have not been
tested in our financial sector.” If Congress moves to eliminate reserve requirements, statutory authority to pay “explicit interest on the remaining balances held at the Federal Reserve would be especially
useful for monetary policy purposes,” Greenspan said.a
Making the Supply of Reserves More Responsive to Fluctuations in Demand
One option to make the supply of reserves more responsive to variations in demand is more frequent trading by the Open Market Desk each day. Indeed, the Desk does sometimes trade more than
once per day.b If reserves continue to decline, making intraday reserve demands still harder to predict, the Desk could act more times each day to offset unexpected movements in reserve demands.
However, because the reserve market isn’t very active by afternoon, trades in the latter part of a day
may not be possible for the Fed, since there aren’t many counterparties with whom to trade.
A second option would be for the Federal Reserve to encourage more active use of the discount
window by depository institutions. When reserve-market pressures push the federal funds rate up,
for example, easy access to the discount window could help ease the pressures. Given the reluctance
of banks to use the discount window, this option would require some adjustments to the window to
encourage greater use.
A third option would also require revisions to the Federal Reserve’s credit facilities. This option,
similar to one employed in many European countries, would combine less administrative restraint
on use of the discount window and a discount rate above the overnight market rates. This so-called
Lombard facility could be useful in dampening upward spikes in the federal funds rate.

a

See Greenspan’s remarks in the Congressional hearing on July 23, 1997. Testifying before the Senate Banking
Committee, Treasury Undersecretary John D. Hawke, Jr., agreed that it would be “more fair to banks” if the Fed
were allowed to pay interest on reserves, but that it would cost the Treasury too much and “it’s not a matter of
great urgency.” For further discussion, see the article "Treasury Hits Fed-Backed Plan to Pay Interest on
Reserves" in the March 11, 1998, American Banker.
b
Trading more than once a day was facilitated by moving up the Desk’s normal intervention time from 11:30
am to 10:30 am. This change was effective January 1997.

tenance period. Therefore, the switch to lagged
reserve accounting eliminates one source of uncertainty about the demand for reserves and consequently should reduce the volatility of the federal funds rate.16 Lagged reserve accounting will
not eliminate all uncertainty about the demand
for reserves, however, as variations in payment
flows can still cause unpredictable fluctuations
in reserve demand and, hence, in the federal
funds rate.17
Should the federal funds rate prove too volatile in the future, the Federal Reserve could

16
Before 1968, contemporaneous reserve accounting
was used to calculate reserves. In September 1968, the Federal Reserve switched to lagged reserve accounting to reduce costs and the difficulties banks faced in calculating
requirements and managing reserves. A switch back to contemporaneous accounting occurred in September 1982 to
tighten the Federal Reserve’s short-term control over bank
reserves and a measure of the money supply called M1,
a supply that varies with changes in bank reserves.
17
For a technical exploration of the link between the volume of payments in the banking system and the volatility
of the federal funds rate, see the article by Craig Furfine
and the article by James Clouse and Douglas Elmendorf.

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NOVEMBER/DECEMBER 1998

adopt other policies toward bank reserves (see
Options for Maintaining Monetary Control in a
World of Shrinking Reserves). Two of the options—
paying interest on reserves and doing away with
reserve requirements—would also eliminate the
incentive for banks to use sweep accounts, or
other means, to evade reserve requirements.18
CONCLUSION
Using sweep accounts to conserve on interest-barren reserve balances has reduced reserves
18
Interest is paid on reserves in Italy, the Netherlands,
and Switzerland. Some countries, such as Canada, currently
operate with zero reserve requirements along with interest
on excess settlement balances and penalties for deficiencies. For details of the Canadian experience, see Kevin
Clinton’s article.

in the banking system. As reserve balances decline, some participants in the financial market
are concerned about the effects on monetary control, particularly the effect on the Fed’s ability to
control short-term interest rates.
To dampen the variability of reserve demand
and to avoid potentially higher variation in
short-term interest rates, the Federal Reserve
Board made a simple change: a return to lagged
reserve accounting. This move will make it
easier for banks and the Federal Reserve to estimate reserve demands, even in the face of continued growth of sweep accounts. While sweeping changes in banks’ reserve management may
continue, it appears that the Federal Reserve’s
ability to hit its target for the federal funds rate
will not be swept away.

REFERENCES
Anderson, Richard G. “Sweeps Distort M1 Growth,” Monetary Trends, Federal Reserve Bank of St.
Louis, November 1995.
Clinton, Kevin. “Implementation of Monetary Policy in a Regime with Zero Reserve Requirements,”
Bank of Canada Working Paper 97-8, April 1997.
Clouse, James, and Douglas Elmendorf. “Declining Required Reserves and the Volatility of the Federal Funds Rate,” Working Paper 1997-30, Finance and Economics Discussion Series, Federal Reserve
Board of Governors, 1997.
Edwards, Cheryl L. “Open Market Operations in the 1990s,” Federal Reserve Bulletin, 83, November
1997.
Feinman, Joshua N. “Reserve Requirements: History, Current Practice, and Potential Reform,” Federal Reserve Bulletin, 79, June 1993.
Furfine, Craig. “Interbank Payments and the Daily Federal Funds Rate,” Working Paper 1998-31,
Finance and Economics Discussion Series, Federal Reserve Board of Governors, 1998.
Meulendyke, Ann-Marie. U.S. Monetary Policy and Financial Markets. Federal Reserve Bank of New
York, 1997.
Richards, Heidi Williams. “Daylight Overdraft Fees and the Federal Reserve’s Payment System Risk
Policy,” Federal Reserve Bulletin, 81, December 1995.
Stigum, Marcia. The Money Market. Dow Jones-Irwin, 1990.
12

FEDERAL RESERVE BANK OF PHILADELPHIA

Is the Fed Being Swept Out of (Monetary) Control?

Jeffrey M. Wrase

Why Is Europe Forming
A Monetary Union?
Gwen Eudey*

E

uropean countries have become more and
more integrated in recent decades. Now, Europeans routinely sell goods and services across
national boundaries, own stocks and bonds
from other countries, and work abroad. But
since each country has its own currency, Europeans spend a lot of time and resources trading one currency for another.
To make their financial lives easier, 11 European countries are joining together to form the

*Gwen Eudey is a visiting professor, Department of
Economics, Georgetown University. When this article was
written, she was a visiting scholar in the Research Department of the Philadelphia Fed.

European Monetary Union (EMU), which will
have only one currency, the euro.1 A common
currency will not only save these countries time
and money, but it will also increase trade within
Europe as well as make it easier for citizens of
one country to buy stocks and bonds in another.
However, monetary union also has costs. European countries can now adjust their exchange-rate and monetary policies in response
1
The EMU will be formed on January 1, 1999. Initial
members will be Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain. For a discussion of the criteria for membership, see the article by Joseph Whitt.

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to severe domestic economic problems. Although
the introduction of a single currency will simplify trade between European countries, each
country will give up the ability to use monetary
policy to influence its economy. No individual
country’s central bank will be able to set interest
rates. And no country in the EMU will be able to
adjust its exchange rate vis à vis the others.
How large a sacrifice will it be to give up independent monetary and exchange-rate policies? The answer depends on the types of macroeconomic “shocks” that hit the economy and
how well other adjustment mechanisms compensate for the lack of exchange-rate flexibility. In particular, it will depend on the degree
to which prices and wages adjust to accommodate those shocks, the degree to which labor
can move across borders, and the extent to
which fiscal policy can be used to control the
economy.
BENEFITS OF A SINGLE CURRENCY
The move to a single currency has many potential benefits. As noted above, reducing the
costs of trading one currency for another is the
most important. A single currency also helps
nations in a number of other ways, such as reducing uncertainty about future exchange rates
and preventing countries from devaluing their
currencies to promote exports.
Reducing Costs of Exchange. When an importer pays for goods, domestic currency must
be exchanged for foreign currency at a bank.
The bank will demand a service charge for this
transaction. For firms that import many supplies or that export to many countries, such
transaction costs may be sizable and will partly
be passed on to consumers through higher
prices. These transaction costs are estimated
to be roughly 0.4 percent of the gross domestic
product of potential members of the European
Monetary Union.2
2

See the article by the European Commission.

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NOVEMBER/DECEMBER 1998

Reducing Exchange-Rate Uncertainty. Although many countries now operate with a flexible exchange-rate system, the countries preparing for monetary union have already limited
how much their currencies move with respect
to each other. Each country stabilizes the exchange rates between its currency and the other
10, and the exchange rates of all move jointly
relative to other currencies in the world.
Policymakers can make large adjustments in the
rate at which one European currency is exchanged for another only when economic circumstances in one country change a great deal
relative to circumstances in the others.
Though large adjustments are infrequent, the
current system allows a fair amount of day-today volatility in exchange rates. The resulting
uncertainty about the future value of a currency
poses a risk for importers and exporters. Imagine a French manufacturer contracting to export a certain amount of equipment to Italy six
months from now. A price will be agreed upon
today, payable in six months in French francs.
If the cost of French francs in terms of lira rises
during that period, the Italian importer will find
herself paying more for the equipment than she
had originally intended. Exchange-rate risk is,
of course, associated only with international
trade, so the Italian importer may prefer a local producer even if the French producer is currently less expensive. Although an importer or
exporter can hedge against possible changes in
the exchange rate by using forward or futures
contracts, this activity is costly.
Thus, exchange-rate risk reduces trade by
imposing a hidden cost on the transaction. A
single currency eliminates all exchange-rate risk
between the countries in the EMU and therefore increases trade and the benefits associated
with it. These benefits include a greater variety of products and lower prices due to competition and economies of scale from producing for a larger market. In fact, many economists believe that one of the greatest benefits
of a single currency comes from its favorable
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Why Fed Being Swept Out of (Monetary) Control?
Is theIs Europe Forming a Monetary Union?

effect on trade from increased competition.
Preventing Competitive Devaluations. Between world wars I and II, European countries
engaged in what are known as competitive devaluations: one country would devalue its currency to boost its export sector, and its trading
partners would retaliate by devaluing their currencies as well. Reducing the value of currency
is inflationary, so competitive devaluations
caused an inflationary spiral during that period. Although the current European exchangerate arrangement is designed to limit the threat
of competitive devaluations, such devaluations
remain possible so long as there are multiple
currencies whose exchange rates are set by
policymakers, rather than determined by the
market as in a floating exchange-rate system.
As trade between European countries has increased, the costs to one’s trading partners from
using a competitive devaluation have increased
but so have the potential gains to any one country. However, the effect of competitive devaluations on the world’s economic welfare is
clearly negative, and it can be disastrous if retaliation leads to a devaluation spiral. A single
currency eliminates the threat of this type of
competition.
Preventing Speculative Attacks. Because it
allows large, though infrequent, exchange-rate
adjustments, the current European exchangerate mechanism is vulnerable to speculative attacks: if speculators believe the value of a currency will be reduced (devalued relative to
other European currencies), they will sell their
holdings. If enough speculators believe this,
confidence in the value of the currency may
collapse and may force the government to devalue even if that had never been its intent.
Although a government can try to thwart
speculators by raising interest rates and thereby
the return to holding money-market instruments denominated in that currency, there’s a
downside to doing so: higher interest rates
mean that business firms face higher borrowing costs, so they’ll do less borrowing and in-

Gwen Eudey
Jeffrey M. Wrase

vesting in new plant and equipment, which, in
turn, will lead to slower economic growth.
The exchange-rate crisis of 1992 illustrates
the effect of speculative attacks on the economy.
Europe at that time had been in a deep recession for two full years; the average European
unemployment rate was approximately 10 percent. Short-term political pressures in the countries most badly hit by the recession argued for
a low-interest-rate policy to stimulate investment and bring about recovery. But such a
policy would be inconsistent with maintaining
stable exchange rates unless the policy were
pursued across all of Europe. If only one country were to lower its interest rates, financial
capital would move out of that country to ones
that still had high rates (so long as capital is
free to move, as in Europe). This movement of
capital would put pressure on exchange rates.
However, although this recession affected all
of Europe, there was no unanimity as to the appropriate interest-rate policy to pursue. The
German government and central bank felt that
they had already excessively stimulated the
German economy in an attempt to help the
former East Germany catch up with the West.
Those policies, they believed, were already putting inflationary pressure on the economy.3 To
offset those inflationary pressures, Germany
was pursuing a high interest-rate policy. Because of Germany’s relative size and economic
importance in Europe, the other European
countries were forced to raise their rates as well
if they wanted to maintain stable exchange
rates. All committed to doing so, but this commitment was not credible in the eyes of currency speculators. Speculators began to bet that
at least three countries—the U.K., France, and
Italy—would succumb to domestic political
pressures and deviate from Germany’s interest
rate policy.
In September 1992 speculators began to bor-

3

See the report by the Bundesbank.
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row British pounds, French francs, and Italian
lira and to convert the proceeds into German
marks and U.S. dollars because they expected
the price of pounds, francs, and lira to fall after
the governments abandoned their commitment
to keep interest rates as high as necessary to
maintain a stable exchange rate. As more and
more speculators sold these currencies, their
value in terms of German marks continued to
fall. In an attempt to attract buyers to their currencies, the British, French, and Italian governments offered very high rates of return on shortterm instruments denominated in their home
currencies. A side-effect of this policy was a
deepened recession in those countries, which
made adherence to fixed exchange rates increasingly unpopular. That unpopularity, in
turn, increased speculation that the policy of
fixed exchange rates would not be sustainable.
Of the three, only France was able to successfully ward off the speculative attack. Both Britain and Italy abandoned their fixed exchange
rates as a result of the speculative pressures.
Although France “survived” the speculative
attack on its exchange rate, survival was costly
in the sense that the high interest rates and increased uncertainty prolonged high unemployment and low growth in that country. Britain
and Italy recovered from the recession more
quickly because lower interest rates and depreciation of their currencies stimulated domestic
spending and exports. But there were costs to
Britain and Italy as well; however, these costs
came later, when inflation rose as a result of
the devaluations.
Since much of the speculative activity within
Europe has occurred when speculators have bet
that one European currency would be devalued relative to another, moving to a single currency would eliminate such activity. And since
investors will not have to be compensated for
uncertainty about exchange rates, interest rates
will fall, thereby stimulating investment and
growth within the EMU. Although interest rates
will fall more in those countries that are now
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NOVEMBER/DECEMBER 1998

subject to the most speculation, many economists think that all countries will benefit from
lower rates as the world economic environment
becomes less risky.
COSTS OF A SINGLE CURRENCY
The benefits of switching to a single currency
don’t come without costs. Probably the biggest
cost is that each country cedes its right to set
monetary policy to respond to domestic economic problems. In addition, exchange rates between countries can no longer adjust in response to regional problems.
As a practical matter, the costs associated
with giving up the possibility of independent
monetary policy may be small for most European countries. As part of their effort to stimulate trade and investment, potential EMU members have eliminated all barriers to international
capital flows, which has created a very competitive multi-country financial market. Consequently, there is little or no difference in the
cost of borrowing (the interest rate) in the different countries so long as exchange rates between European currencies are kept fairly
stable. This European interest rate is determined by the large European countries, implying that small countries in the European Union
do not have the ability to lower interest rates
during recessions unless they are willing to see
their currencies devalued. In other words, European financial and exchange-rate treaties
have left small member countries effectively
without the ability to conduct independent
monetary policy. But all member countries will
have representation in monetary policy decisions after monetary union. The EMU will give
small countries some influence in determining
the European interest rate even as it formally
eliminates the possibility of using independent
monetary policy and exchange-rate adjustments.
The EMU member countries have also
agreed to limit the use of fiscal policies. Consequently, when one or several countries within
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Is the Is Europe Forming a Monetary Union?
Why Fed Being Swept Out of (Monetary) Control?

the currency union, but not all, face recession
or an overheated economy, adjustment must
occur largely through changes in wages and
prices or through the movement of workers
from one country to another.
Monetary Policy. The biggest change in
moving to a single currency is that each country will relinquish control over monetary policy
to the new European central bank that will issue the single currency for all the countries in
the union. But what happens if a recession hits
just one country? Currently, its central bank
may respond to the recession by increasing the
money supply, thereby pushing interest rates
downward and stimulating investment and
economic recovery. The central bank for the
European Monetary Union will be unlikely to
use expansionary monetary policy to help one
country, since doing so would cause inflation
in those EMU countries not in recession.
To illustrate the consequences of having a
single currency when there are disparate regional interests, let’s consider a scenario in
which Europe already had a single currency in
1992.
A single European currency in 1992. What
would have happened had there been a single
European currency at the time of German reunification and the 1990-92 recession if a European central bank had raised interest rates as
the German central bank did? Consider first the
implications for Britain and Italy: Britain and
Italy devalued their currencies and lowered
interest rates to stimulate exports and investment, allowing them to recover more quickly
from recession but at the eventual cost of inflation. If they had been members of a currency
union following Germany’s interest-rate policy,
they would not have been able to devalue, nor
would they have been able to lower interest
rates to stimulate investment for a quicker recovery. Thus, Germany would have combated
its inflation through the high-interest-rate
policy of the currency union, but Britain and
Italy would have had prolonged recessions.

Jeffrey M. Eudey
Gwen Wrase

In lieu of reducing interest rates and devaluing their currencies, Britain and Italy might
have used fiscal policy to stimulate their economies. Both nations could have cut taxes or increased public investment to stimulate aggregate demand during the recession, but such
actions would have increased budget deficits
and required additional government borrowing. Large and persistent government borrowing by one or more countries could impose costs
on all countries in the monetary union by putting upward pressure on interest rates or by
forcing the European central bank to increase
the money supply to avoid higher interest rates,
thus risking higher inflation. Therefore, European governments have agreed that none of the
countries participating in the EMU will allow
its yearly budget deficit to exceed 3 percent of
its GDP. Moreover, participating countries have
agreed that any country whose budget deficit
exceeds that cap will pay substantial penalties
to the others. These agreements prevent countries from issuing excessive amounts of government debt over the long run, but they also
seem likely to restrict each country’s ability to
use stimulative fiscal policy during recessions.
These agreements do not, however, prevent
using a federal fiscal policy to address regional
imbalances in the currency union: those regions
that are overheating could be taxed more
heavily and the proceeds spent in the areas in
recession. In the example above, policymakers
in 1992 might have cooled inflationary pressures in the western part of Germany by raising taxes there and might have stimulated recovery in Britain, Italy, and France by spending the extra tax revenue on public investment
in those countries. Currently, the federal budget for the European Union is not used as a tool
to address recessions or overheating, either in
particular countries or in Europe as a whole.
Of course, if economic adjustment from recessions happens quickly, there is very little cost
associated with giving up interest- or exchangerate policy and no need for federal redistribu17

BUSINESS REVIEW

tion. The speed of recovery depends greatly on
the flexibility of the European labor market. If
workers are highly mobile, British and Italian
workers who are unemployed or earning low
wages during the recession will quickly relocate to Germany or other countries that have a
high demand for labor. This type of flexibility
has an equalizing effect across the monetary
union and makes for greater symmetry in
policy objectives. In Europe, however, cultural
and linguistic differences hinder labor movements across countries, so this particular type
of labor-market flexibility is not promising in
the near future.
A second form of labor market flexibility occurs through wage adjustments. If, in a recession, workers are willing to accept lower wages,
employers will not only be able to maintain the
same number of employees but also to pass on
the reduction in payroll costs in the form of
lower prices. Lower prices, in turn, spur exports
and lead domestic consumers to buy fewer
imports and more locally made goods. That
increase in demand spurs economic recovery.
In practice, however, although wages seem to
go up during booms, they do not fall so readily
during recessions.
Thus, given that budget deficits in Italy and
Britain in 1992 were already at or above 3 percent of GDP and that European labor markets
are fairly inflexible, recovery in those two countries would have been much slower had they
been members of a monetary union that followed Germany’s high-interest-rate policy.
France, however, might have experienced a
quicker recovery under monetary union because French policymakers, determined to prevent devaluation of the franc and the resulting
inflation, responded to the speculative attack
by raising interest rates even more than Germany had. Thus, monetary union would have
imposed no additional burden on the French
economy, and moreover, it would not have suffered the destabilizing consequences of foreignexchange speculation. Thus, it is important to
18

NOVEMBER/DECEMBER 1998

understand not only how regions differ in terms
of their position in the business cycle but also
cultural preferences and differences in
policymakers’ goals.
The 1990-91 recession: The U.S. experience. The
United States also suffered a recession during
the 1990-91 period. Although the recession was
less severe in the United States than in Europe,
the United States experienced regional differences in the severity and length of the downturn. The recession came as federal military expenditures were being cut back, and regions
such as southern California, which had a heavy
concentration of defense contractors and military bases, were particularly hard hit. Consequently, unemployment in California was
higher than in the rest of the country; by 1993,
U.S. unemployment was only 6.5 percent while
in California unemployment stood at 8.6 percent.
The federal tax and transfer system aided
unemployed Californians through unemployment benefits. The federal government also
aided the region by subsidizing conversion of
military bases to commercial use, the revenues
for which came from more prosperous regions
of the country. Labor-market flexibility also contributed to eventual recovery as workers migrated from California to neighboring states.
Although direct evidence of worker migration
is hard to come by, one careful study indicates
that there was a net immigration of about
200,000 people from other states to California
from mid-1989 to mid-1990 (just before the recession began) and a net out-migration of more
than 250,000 people from mid-1993 to mid1994.4 That out-migration was just under 1 percent of California’s population. The outflow of
the labor force, of course, put competitive
downward pressure on wages in neighboring
states, another painful part of the adjustment
process.5
The relatively deep California recession also
4

See the study by Hans Johnson and Richard Lovelady.
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Why Fed Being Swept Out of (Monetary) Control?
Is the Is Europe Forming a Monetary Union?

hurt neighboring states by reducing their firms’
sales to Californians, which resulted in further
job losses, most especially in Arizona, Nevada,
and Hawaii. Thus, the flexibility of the labor
market helped bring about recovery in California, but at the expense of exporting recession
and unemployment to the rest of the region. In
this particular example, fiscal transfers, sustained demand for the non-military goods sold
to other states, and the availability of jobs in
neighboring states lessened California’s pain.
However, in spite of these means of adjustment,
which are necessary in a monetary union such
as the United States, the relatively high unemployment that remained in California in 1993
demonstrated that the adjustment process in the
United States is still a difficult one despite the
country’s relatively high labor-market flexibility and large fiscal budget.
REDUCING THE COSTS AND
PRESERVING THE BENEFITS
The examples above show that the keys to a
currency union’s ability to adjust to economic
shocks are the degree to which wages and prices
are flexible and the ease with which labor
moves across borders. So how is Europe likely
to fare?
European Labor Markets Are Inflexible. Although labor-market flexibility can substitute
for a policy response, labor-market flexibility
in Europe is clearly much lower than that in
the United States.6 Compared with their U.S.
counterparts, European workers are much more
willing to remain unemployed rather than accept lower wages. They are also much less willing to move out of regions with high unemployment rates. This situation is only partly due
to the language and cultural barriers that hinder
cross-country movements; European workers
5

See the article by Brian Cromwell.

Gwen Wrase
Jeffrey M. Eudey

are also less likely to move within their own
countries in response to labor-market pressures.
This reluctance may reflect the relatively high
unemployment compensation in Europe.7
European governments recognize the need
for greater labor-market flexibility, but attempts
at labor-market reform are controversial. There
has been some progress, however. For example,
workers are now free to move across national
borders, and this movement can reduce the cost
of regional shocks. But it seems unlikely that
European labor markets will be able to meet
the demands for flexibility in the short run, following formation of the EMU.
The costs associated with losing independent
monetary and exchange-rate policy might be
small if there were either little evidence of regional asymmetry or great evidence of labormarket flexibility. In the European case, the opposite is true. In a well-known paper, Tamim
Bayoumi and Barry Eichengreen find not only
that shocks are more symmetric across regions
in the United States but that labor markets in
the U.S. regions stabilize much more quickly
than labor markets in European countries.
These findings seem to suggest that Europe will
not form as successful a monetary union as that
in the United States, since regional losses may
be greater in Europe than the U.S. experience
would suggest, but that conclusion might be
premature.
Examination of labor-market flexibility compares the abilities of the United States and Europe to adjust to economic shocks. But comparing the shocks, as Bayoumi and Eichengreen
do in their paper, may not be appropriate because it involves comparing asymmetries
within an existing monetary union to those in
a potential one. After inauguration of the EMU,
sources of asymmetry will be reduced. For example, the EMU will eliminate asymmetries in
setting monetary policy. Furthermore, countries

6

See, for example, the article by Tamim Bayoumi and
Barry Eichengreen.

7

See the article by Jose Vinals and Juan Francisco Jimeno.
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BUSINESS REVIEW

that run fiscal deficits out of line with the European norm will be fined. In addition, the U.S.
federal income tax and welfare systems redistribute income from expanding to contracting
regions; this leveling effect may make U.S. regions appear more symmetric in their cyclical
movements than their European counterparts.
As similar tax and welfare policies take hold
within the European Union, redistributive policies may create more symmetry across regions
there as well.8
Although a single currency should lessen fiscal and monetary sources of asymmetry, there
are, at the same time, reasons to suspect that
adoption of a single currency may increase
asymmetry within the EMU. By reducing transaction costs, adopting a single currency may
increase trade. Trade tends to encourage regional specialization in the production of goods.
If regions specialize in the types of goods they
produce, shocks to demand or to the production of any particular good will affect regions
differently. If monetary union does increase
trade, regions within the common-currency
area may become less alike than they are now.
Ambiguity about the effect of monetary union
on the structure of the economy makes evaluation of the potential costs and benefits of the
EMU highly speculative.9
Could Fiscal Policy Help? Faced with asymmetric shocks, members of the EMU may have
to rely more heavily on fiscal policy to compensate for the lack of independence in setting
monetary policy. The current trend in Europe,
however, leans toward the reduction of national
budgets. As indicated earlier, taxation and redistribution across EMU countries may be a

8

See the article by Barry Eichengreen for a discussion of
the anticipated role of tax and welfare policies across EMU
member countries.
9

See the article by Maurice Obstfeld for a description of
the mechanics behind conversion to the single currency.
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NOVEMBER/DECEMBER 1998

promising approach. But the European Union’s
budget is currently much too small for such a
task; however, it may increase to meet the demands of post-monetary-union Europe in the
next century.
How Do Countries in Europe Compare
with Each Other? At one time economists referred to Europe as consisting of a “core” and a
“periphery,” with the core represented by the
U.K., France, Germany, and perhaps Austria,
and the periphery by the Mediterranean countries. Relatively large budget deficits and high
inflation rates distinguished “peripheral”
countries, as did the fact that their business
cycles were rarely in sync with those in “core”
countries.
This breakdown is no longer as clear as it
once was, however. Budget deficits in Germany
and France have grown over the past eight or
nine years, while those in the once-peripheral
countries have fallen, as have their interest and
inflation rates. German re-unification represented a large asymmetric shock, relative to the
rest of Europe, from which Germany is still recovering.10 Nonetheless, Europe as a whole has
undergone a period of dramatic convergence
in interest and inflation rates and government
budget deficits since the ratification of the
Maastricht Treaty on monetary union in 1993.
This convergence may indicate increasing symmetry and harmony in policy objectives as the
January 1, 1999, date for monetary union approaches.
SUMMARY
There are both costs and benefits associated
with forming any monetary union. The benefits
of monetary union stem from reducing transaction costs and eliminating exchange-rate uncertainty. Falling transaction costs mean fewer
barriers to trade, which should increase com-

10

See the article by Hans Werner-Sinn, which treats German re-unification as an asymmetric shock within Europe.
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Is theIs Europe Forming a Monetary Union?
Why Fed Being Swept Out of (Monetary) Control?

petition and reduce prices. Eliminating exchange-rate uncertainty will spur still more
trade; it may also lower interest rates, therefore making it cheaper to borrow to finance new
investment. In the European case, the benefits
may be greater still because if each country has
its own currency, speculative pressures
heighten the risk of costly exchange-rate movements.
The costs depend on the extent to which
member countries would prefer to use independent exchange-rate and monetary policies, on
the asymmetry of shocks to their economies,
and on how willing unemployed workers are
to move or accept wage cuts. Compared to the
United States, EMU countries are more likely
to experience regional shocks, and these shocks

Jeffrey M.Eudey
Gwen Wrase

are less likely to meet with speedy labor-market
adjustment.
Whatever the costs of EMU, mechanisms
other than domestic monetary or exchange-rate
policy will have to bear the burden of economic
adjustment after adoption of the single currency. Barriers to movements of labor have
been removed, which encourages that adjustment process. Further labor-market reforms
may be necessary to increase labor markets’
speed of adjustment. In addition, member countries may find it necessary to institute international tax and redistribution policies through
growth of the European Union’s budget to allow for regional differences in policy stimulus
or restraint.

REFERENCES
Bayoumi, Tamim and Barry Eichengreen. “Shocking Aspects of European Monetary Union,” in Francisco Torres, Francisco Giavazzi, and Francesco Giavazzi, eds., The Transition to Economic and Monetary Union, Cambridge University Press, 1993, pp. 193-240.
Bundesbank. Monthly Report of the Deutsche Bundesbank, December 1991.
Cromwell, Brian. “California Recession and Recovery,” Federal Reserve Bank of San Francisco Weekly
Letter Number 94-17, April 29, 1994.
Eichengreen, Barry. “Fiscal Policy and EMU,” in Barry Eichengreen and Jeffrey Frieden, eds., The
Political Economy of European Monetary Unification. Boulder, Colo: Westview Press, 1994, pp. 167-90.
European Commission. “One Market, One Money: An Evaluation of the Potential Benefits and Costs
of Forming an Economic and Monetary Union,” European Economy 44, 1990.
Johnson, Hans P., and Richard Lovelady. “Migration Between California and Other States: 1985-1994,”
California Demographic Research Unit Research Paper, November 1995.
Obstfeld, Maurice. “Europe’s Gamble,” Brookings Papers on Economic Activity, 2: 1997, pp. 241-314.
Vinals, Jose, and Juan Francisco Jimeno. “Monetary Union and European Unemployment,” Centre for
Economic Policy Research Discussion Paper 1485, London, 1996.
Werner-Sinn, Hans. “International Implications of German Unification,” Working Paper 5839, Cambridge, Mass.: National Bureau of Economic Research, November 1996.
Whitt, Joseph. “Decision Time for European Monetary Union,” Economic Review, Federal Reserve Bank
of Atlanta, 1997, 82, pp. 20-33.

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