NU Online News Service, Dec. 4, 2003, 8:33 p.m. EST – A group of researchers at the European Union’s Directorate General for Economic and Financial Affairs has stirred up an international storm by discussing the conditions under which the union could impose controls on capital flows.[@@]

The Telegraph, a British newspaper, drew attention to the researchers’ analysis earlier this week by publishing a report that suggests the team addressed the topic because of the recent rapid rise of the value of the euro relative to the dollar.

Although the treaty that governs the European Union appears to prohibit all restrictions on capital movements, some treaty articles “offer several possibilities either to limit this principle of absolute freedom of capital movements or to be exempted from it,” the economic affairs researchers write in the analysis, which appears at the end of “The EU Economy: 2003 Review.”

Member states can “take measures which are justified on grounds of public policy or public security,” and that concept could expand, the researchers write.

EU articles also let member states restrict capital movements when national security is threatened, and one article lets member states adopt restrictive measures for up to 6 months to cope with “extremely disturbing capital movements with third countries” located outside the union, the researchers write.

In the past, international trade negotiators from many countries have emphasized the importance of a free flow of capital in strengthening the world economy. European officials responded to the Telegraph article by downplaying the possibility that the union might adopt capital flow controls.

The recent weakness of the dollar has helped U.S. insurers with large operations in Europe and Japan, but it has hurt the reported earnings of European financial services companies with large insurance operations in the United States. The strong euro also has hurt efforts of European manufacturers to export to the United States.

Economists have attributed the weakness of the dollar to Federal Reserve officials’ efforts to nurse the U.S. economy back to health and the Bush administration’s interest in using a weaker dollar to help U.S. manufacturers.

Although the weakness of the dollar relative to the euro could imply an impending return of high rates of inflation, John Lonski, the chief economist at Moody’s Investors Service, New York, says the Treasury markets show traders believe the U.S. inflation level is firmly under control.

If traders believed unacceptably high rates of inflation were returning, Treasury yields would be at least half a percentage point higher than they are today, Lonski says.

Besides, Lonski says, the current value of the dollar relative to European currencies is now similar to what it was during the first years of the economic recovery in the early 1990s.

Lonski adds that he sees no evidence that the world’s central banks are worried about the euro-dollar exchange rate.

But, if the European Union did impose restrictions on capital flows, “to me, that would be an unusual move, given that the euro is a major currency,” Lonski says.

Lonski declined to discuss whether European capital flow restrictions might affect the overall level of global political risk.

The EU has posted a copy of the analysis and economic review at http://europa.eu.int/comm/economy_finance/publications/european_economy/2003/com(2003)729_fullversion_en.pdf