EU

Question 1

What are the benefits of free trade and free mobility of labour and capital

Answer 1

More trade and gains from comparative advantages
Greater competition
Increased direct investment
Flexible labour markets (few occupational immobilities)

Question 2

What are the convergence criteria

Answer 2

Inflation rate no more than 1.5% points above the average of the countries with lowest inflation rate
Nominal interest rates not above 2% of the 3 lowest countries in the EU
Stable exchange rate against the Euro 2 years prior to entry
Budget deficit not in excess of 3% of GDP
Debt to GDP ratio not exceeding 60%

Question 3

What is the need for convergence criteria

Answer 3

Price stability —> ensures new members don’t suffer from falling competitiveness
Price stability —> stable inflation means a single interest rate would work
Public finances —> reduce need for bailouts by ECB
Exchange rate stability —> ensures countries joining at appropriate rate so they don’t lock into a currency that is overvalued/undervalued preventing competitiveness issues

Question 4

What are the advantages of a monetary union

Answer 4

Business uncertainty —> reduce ER uncertainty for business
Increased price transparency —> easier to compare prices from one country to another —> encourage expansion of cross border trade and increase competition
FDI —> removing currency barrier to trade improves development of MNC
Increase competitiveness —> incentive to do this as country can no longer rely on devaluation to improve competitiveness

Question 5

What are the disadvantages of a monetary union

Answer 5

Monetary policy freedom —> cannot tailor domestic interest rates based on internal macro objectives
Exchange rate inflexibility —> no longer devalue the exchange rate if joined the monetary union on a exchange rate that’s too high
Independence over fiscal policy —> growth and stability pact limits gov borrowing to no more than 3% of GDP —> reduce budget deficit countries had to pursue austerity
Inflationary fears —> require high interest rates across the Euro Area which are unsuitable for another area
Interest rate changes —> UK has lots of mortgages so interest rate changes by EU will have effect on the housing market via variable rate mortgages