Chapter 15 Flashcards
what is the gold standard?
1870-1914
many major currencies were convertible to gold at fixed prices
what is the Bretton Woods system?
most major currencies had a fixed exchange rate relative to the dollar
was convertible to gold at a fixed price
- the USD has been floating since this system broke down
What is the European Rate Mechanism (ERM)?
Introduced 1979
Stipulated that all participating central banks should keep the exchange rate w.r.t other currencies with narrow intervals
lead to greater exchange rate stability
What does the possibility of devaluation mean for financial markets?
means there may be speculation in financial markets about the future change in exchange rates
Why does the speculation create a serious dilemma for the central bank?
The Central bank has to set a high interest rate which has negative effects on the economy, leading to further speculation that the currency will be devalued. At some point it may become too costly to defend the exchange rate and the central bank may be forced to devalue the currency. EG ERM crisis in 1992
What did the Maastricht treaty and the stability and growth pact state?
1992 and 1997
stated that the government deficit should not exceed 3% GDP and gross consolidated government debt shouldn’t exceed 60% GDP. There are some escape clauses
What do statistical estimates indicate about the euro and trade?
has increased by 35%. trade between euro and non euro countries have also increased
what do statistical estimates indicate about inflation and growth in the eurozone?
inflation in the eurozone approx 2%
this is not very different from average for similar countries with a floating ER and inflation targets
growth in the euro zone has been weak. the IR has been lower than average
why are fiscal problems harder to deal with in the Eurozone?
as the countries can’t use monetary policies especially if there is a problem of competitiveness
what is the advantages of a monetary union?
reduced transaction costs
easier to compare prices
less uncertainty in short and medium run
it should faciliate trade but the effects on investment and growth is less clear
what is the main cost of a monetary union membership?
country cant adjust interest or exchange rates to economic conditions in home country. some countries may end up with serious imbalances
what are the main adjustment mechanisms within a monetary union?
wage and price adjustment
labour mobility
national and federal fiscal policy
within EU national fiscal policy plays central role
what does the theory of optimum currency areas say?
the choice to join MU involves a comparision of costs and benefits. the more politically and economically integrated countries are the greater the benefits
