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Laurin > International Money and Finance > Flashcards

International Money and Finance Flashcards

1
Q

Definition of exchange rate (def. 2)

A

-> The exchange rate is expressed as the amount of foreign currency that equals one unit of domestic currency (foreign currency is always 1).

-> When the exchange rate (S) increases it means that the price of the foreign currency has increased, which results in the foreign currency appreciating.

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2
Q

The spot exchange rate

A

Price for immediate transaction

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3
Q

The forward exchange rate (2)

A

(1) price & (2) transaction date is certain.

*There is no risk involved - however F and S are closely correlated.

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4
Q

Hedgers

A

Enter forward market to protect themselves.

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5
Q

Speculators

A

Agents that hope to make a profit by accepting exchange rate risk.

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6
Q

Arbitrageurs

A

Riskless profit based on interest rate differentials.

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7
Q

-> Forward premium

A

is when the forward exchange rate represents an appreciation for that currency compared to the current spot.

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8
Q

-> Forward discount

A

forward exchange rate quotation represents a depreciation.

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9
Q

Nominal exchange rate (S)

A

The price of one currency in terms of another

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10
Q

Real exchange rate (Sr)

A

Corrects for price differences

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11
Q

Exchange rate regimes (3)

A

(1) Fixed exchange rate: the central bank buys/ sells currencies to keep the exchange rates fixed.

(2) Floating exchange rate: The exchange rate is only determined by supply and demand.

(3) Intermediate regimes: Central bank influences rate

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12
Q

Retail clients

A

Dutch importer who needs dollars

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13
Q

(Commercial banks) banks

A
  • Sell dollars to importer
  • Buy dollars from another bank
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14
Q

Forex (FX) brokers

A

Intermediary for banks: gains from economies of scale

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15
Q

Central banks (ECB, Fed, …)

A

Intervene (i.e. buy/sell H currency) to influence the value of H currency

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16
Q

GDP

A

Value added WITHIN the country

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17
Q

GNP

A

Value added by all the nation’s factors of production

*Value added = total sales - intermediary purchases

*Value added = final sales - intermediary exports - intermediary imports

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18
Q

Private savings (S) (3)

A

= Output (Y) - Tax (T) - Consumption (C)

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19
Q

Government deficit surplus

A

= Tax (T) - Government spendings (G)

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20
Q

Total savings

A

= Private savings + Government savings

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21
Q

Formula GDP (Y)

A

Y = C + I + G + X - M - T

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22
Q

National Savings Identity (CA) (4)

A

CA = S - I + T - G

Current Account = private savings surplus + govt. budget surplus

*Related to national income identity but with international focus

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23
Q
  1. Current account, CA
A

-> Income flows

a. Goods accounts/trade balance (exports-imports) (visible trade)
b. Service account (services, transportation)
c. Income account (Interest, profits, dividends)
d. Unilateral transfers account (Gifts, EU contribution, fall in domestic income due to payment to foreigners)

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24
Q
  1. Capital and financial account, (K or KA)
A

-> Changes in assets & liabilities of the private sector and non-central-bank public sector. Plus and minus depends on if it is cash in or out flow.

a. Portfolio investment (stocks, bonds)
b. Direct investment (physical capital)
c. Nonfinancial, non-produced assets (patents, copyrights)
d. Capital transfers (asset ownership transfers, debt forgiveness)

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25
Q
  1. Settlements account (ORA). (3)
A

-> Transaction by the Central Bank

a. Official forex intervention (buying H currency at forex market)
b. Selling gold
c. Borrowing from IMF or foreign CBs

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26
Q

Balance of payments and its accounts

A
  1. Current account (CA)
  2. Capital and financial account (K or KA)
  3. Settlements account (ORA)

-> BoP = CA + K + ORA

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27
Q

Net international investment position (NIIP)

A

Total value = H-owned assets (real & financial) in F – F-owned assets in H

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28
Q

NIIP changes due to two reasons (2)

A

A. Current Account: net issuance of new assets
B. Valuation effects: changes in the valuation of existing assets
- Local currency value of assets
- Exchange rate

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29
Q

Internal Balance (IB)

A
  • Full employment
  • Stable prices (or stable inflation)
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30
Q

External balance (EB)

A
  • CA equilibrium (because a long-run deficit or surplus is problematic)
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31
Q

X-Axis (Swan Diagram) (3)

A

Absorption = domestic spending = Consumption (C) + Investment (I) + Government spending (G)

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32
Q

Y-Axis (Swan Diagram)

A

Real exchange rate Sr = (SP/P) *quantifies competitiveness

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33
Q

Disadvantages of Swan: (2)

A

(1) Focus on EB not IB
(2) No international capital movements

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34
Q

Mundell - Fleming model

3 Market equilibria:

A

Internal focus (focus on Y):
(1) IS: equilibrium on the goods market – Output/ Income
(2) LM: equilibrium in the money market – Interest rate

External focus (focus on r):
(3) BP: equilibrium on the forex market – Exchange rate

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35
Q

Macroeconomic trilemma I

A

Fixed exchange rate & perfect capital mobility
⇒ Is monetary policy effective?

  • If the country increases M, the interest will decrease and therefore also the exchange rate. To keep the exchange rate fixed, the country will have to sell foreign currency and buy domestic one. This action to keep the exchange rate fixed cancels out the effects of the monetary expansion.-> NOT possible
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36
Q

Macroeconomic trilemma II

A

floating exchange rate & perfect capital mobility ⇒ is fiscal policy effective?

Fiscal policy increases government spendings -> financed with debt (inflow foreign capital) -> appreciates the currency -> less competitive exports -> decreases the current account -> decreases output (Y) and interest rates also find a new equilibrium.

-> NOT possible

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37
Q

PPP law of one price (def.)

A

-> It states that the price levels between two countries should be equal (=law of one price) this is achieved by the exploitations of arbitrage opportunities. This means that goods in each country will cost the same once the currencies have been exchanged  power parity (PPP)
*Invalid in the short run.

-> P = S * P

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38
Q

Deviation from PPP (3)

Economic reasons

A
  1. Trade costs and 1. Trade costs and impediments -> goods arbitrage ↓
  2. Tradables vs. non-tradables (see next slides)
  3. Productivity differentials: Balassa-Samuelson
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39
Q

Balassa-Samuelson explanation

A

-> In rich countries the productivity for tradables is higher and therefore the prices for all products.

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40
Q

Limitations of PPP (3)

A
  • Cannot explain large fluctuations in the exchange rate
  • Ignores money and capital flows
  • Ignores exchange rate expectations
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41
Q

Uncovered Interest Parity (UIP) (def.)

A

-> UIP implies that the expected rate of return on domestic and foreign bonds is equal. The effects of the future exchange rate equal the interest rate benefits out (r = r* + Es°).

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42
Q

What are the three markets to clear?

Flexible (goods) price - Clearing conditions

A
  1. Money market
  2. Goods market
  3. Bonds market
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43
Q
  1. Money markets (m)

Flexible (goods) price - Clearing conditions

A

-> Cleared by prices

Money supply ↑; leads to a depreciation of the currency S↑; P ↑ to hold PPP

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44
Q
  1. Goods market (i)

Flexible (goods) price - Clearing conditions

A

-> Cleared by exchange rate.

Domestic income rises ↑-> domestic prices ↑ -> exchange depreciates to hold PPP.

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45
Q
  1. Bonds market (r)

Flexible (goods) price - Clearing conditions

A

-> Cleared by interest rates.

Interest rates increase ↑; exchange rates appreciate ↑; future expected exchange rate decrease ↓ (regressive expectation); interest rate decreases ↓ to hold UIP

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46
Q

Flexible (goods) price - Deficits of the model (3)

A
  • Assumes that PPP continuously holds.
  • Prices are flexible upwards and downwards like exchange rates.
  • Floating exchange rates are adopted.
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47
Q

Real interest parity (RIP)

A
  • Open economies have equal real interest rates in the long run (UIP & PPP)

-> RIP: r = r* + Ep° - Ep *°

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48
Q

Exchange rate equation variables (3)

A
  • Relative money supply
  • Real income
  • Real interest rate
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49
Q

Expectations matter (2)

A

-> Current exchange rate depends on expected future depreciation
a. Es *↑ -> r↑ -> md↓ -> p↑ -> s↑

-> Exchange rate is like an asset price (can be volatile considering future expectations)

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50
Q

Sticky price modle assumptions (4)

A
  • For short and long run
  • Goods prices and wages are sticky
  • PPP NOT assumed
  • Overshooting is possible
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51
Q

Different categories

Sticky price model - clearing conditions

A
  1. Money market
  2. International bond market
  3. Domestic good market
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52
Q
  1. Money market

Sticky price model - clearing conditions

A

-> cleared by r (interest rate)

Equilibrium: m,s = m,d
- Money market cannot be cleared by prices because prices are sticks, therefore it must be done by the interest rate.

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53
Q
  1. International bonds market

Sticky price model - clearing conditions

A

-> cleared by s (exchange rate)

Equilibrium (UIP): r = r*+Es° (where regressive expectations -> cheap currency is expected to appreciate)

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54
Q
  1. Domestic good market

Sticky price model - clearing conditions

A

-> cleared by p (goods prices)

Phillips curve p°= π (d-y) (changes in price level because of inflation, π determines how fast the prices adjust because of excess demand)

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55
Q

Derivation of the goods-market equilibrium schedule (3)

A
  1. A depreciated exchange rate boosts demand for a country’s exports by making them cheaper for foreign buyers.
  2. If the domestic price level rises (inflation), it can offset the initial competitiveness gained from the depreciation. Higher prices make exports more expensive, reducing the benefit of the depreciated exchange rate.

-> For a country to remain competitive after an exchange rate depreciation, the rate of depreciation must be greater than the rate of domestic inflation to effectively boost export demand and keep the economy balanced.

56
Q

Derivation of the money-market equilibrium schedule (3)

A
  • Balances price levels and exchange rates to maintain economic stability.
  • In times of high money supply and falling prices, interest rates are lowered to boost spending and counteract deflation.
  • To attract investment despite low interest rates, there must be an expectation that the currency will appreciate in the future.
57
Q

Sterilized intervention:

A

Intervention into the foreign exchange market, doesn’t impact the domestic money supply. Short-term approach.

Money has real effects in short and medium run,
but is neutral in long-run.

58
Q

Non-sterilized intervention:

A

Authorities change reserves to directly affect the domestic money supply. Long-term approach.

Money has real effects in short and medium run,
but is neutral in long-run.

59
Q

Sources of risk (risk premium) (5)

A
  1. Currency risks:
    1.1 Inflation risk (losing purchasing power)
    1.2 Exchange rate risk (losing money due volatile exchange rate)
  2. Country risks
    2.1 Exchange control risk (gov. regulations affecting conversion of currency)
    2.2 Default risk
    2.3 Political risk (politics affecting investment)
60
Q

Assumptions (risk premium) (4)

A
  • Bonds are no perfect substitutes -> UIP does not hold

(1) Investors are rational.
(2) Investors are risk averse.
(3) Difference between risk minimizing portfolio and actual portfolio.

61
Q

Formula risk premium

A

RP = r - r* - Es°

62
Q

Advantages of fixed exchange rate (5)

A
  1. Promote international trade and investment. (reduces uncertainty)
  2. Discipline for macroeconomic policies (No option to use monetary policies)
  3. Promote international cooperation and coordination (align exchange rate targets with other gov.)
  4. Speculation under floating rates are mostly destabilizing
  5. Monetary policy is ineffective
63
Q

Advantages of floating exchange rate (5)

A
  1. Ensure a balance of payments equilibrium (equil. supply and demand of currency)
  2. Ensure monetary policy autonomy (determine own inflation rate, money supply)
  3. Insulate economies from foreign price shocks. (due to appreciating exchange rate)
  4. Promote economic stability. (depr. Exchange rate instead of decrease of domestic prices to keep competitiveness)
  5. Fiscal policy is ineffective.
64
Q

Advantages managed floaring exchange rate regime (3)

A

Assumption: Authorities can influence/ intervene exchange rate if the benefits outweigh the costs.

  1. CB may produce a better exchange rate (authorities see the bigger picture)
  2. Intervention is needed to mitigate the costs of exchange rate overshooting. (reduce cost)
  3. Intervention to smooth the economic adjustment process.

-> The exchange rate should be allowed to adjust freely to the exchange rate. However, it makes sense to slow down the adjustment process.

65
Q

Which regime is best for: Lower-developed countries (3)

A

-> Fixed exchange rate, rigidity goes with better economic performance.

  • Rigidity enhances policy credibility despite poor financial institutions.
  • Low exposure to international capital markets
66
Q

Which regime is best for: Emerging markets (3)

A

-> Floating exchange rate, flexibility goes with better economic performance.

  • Better financial institutions, therefore enhanced policy credibility is less relevant.
  • Higher exposure to international capital markets.
67
Q

Which regime is best for: Developed countries. (3)

A

-> Floating exchange rate goes better with economic performance
- More instruments to hedge consequences of exchange rate misalignment.
- Exchange rate is the adjusting variable in world of other rigidities.
*Faster growth with higher inflation

*sidenote about best exchange rate regime
-> NO clear overall choice possible, depends on the specific situation.

68
Q

Gold Standard (1870-1914) (2)

A
  • Fixed exchange rate of national currency to gold
    -> Stability: good for international trade.
69
Q

World War I (1914-1918) (2)

A

*Need for flexibility to finance military expenditures.
-> Suspend gold standard, lead to inflation

70
Q

Reconstruction (1918 – 1920) (2)

A

*Reconstruction financed by printing money: flexibility
-> Inflation (German hyperinflation)

71
Q

Gold exchange standard (1920) (2)

A

*Search for financial stability but without the limitations of expanding monetary policy to create growth.
Gold exchange standard
- Reserves of smaller countries = gold + currencies of larger countries
- Reserves of larger countries = gold

72
Q

Economic depression (1930) (3)

A

*Countries tried to obtain internal balance (employment) but had to achieve external balance (fixed exchange rate). Internal Balance was more important than External Balance.
- Competitive devaluation
- Trade restriction to support domestic market.
- Many countries left the gold standard for monetary pol. autonomy. (floating rates)

-> Disintegration/ instability

73
Q

Bretton woods system and its institutions (1940s) (3)

A

*Need for a system which allows IB & EB which gives discipline + flexibility.

1) Fixed but adjustable exchange rate
- (F to $ was pegged, but adjustable, +/-1% and the $ to gold with 35$/ ounce)

2) IMF (international monetary fund)
- Give loans to countries with temporary BoP problems.
- 25% reserves in assets 75% reserves in own currency which can be lend
3) IBRD (international Bank for reconstruction and development) now part of the world bank
- Goal is poverty reduction

74
Q

Triffin dilemma (2)

A
  • Either the quantity of dollars is OK, but quality is not OK or,
  • The quality of dollars is OK, but the quantity is not OK.
74
Q

Breakdown of Bretton Wood system (1960s) (story)

A

Because of the spending in the Vietnam war, the US increased the money supply, leading to higher inflation and a weaker dollar. To maintain fixed exchange rates, other countries sold their own currencies and bought dollars. This increased their money supply and spread US inflation to these countries.

-> The us could not devalue further to avoid losing trust

74
Q

Downside of Bretton Wood system (2)

A
  1. Liquidity and confidence problem
  2. Adjustment problems, preferring IB over EB, governments did not want to adjust exchange rates.
75
Q
  1. Adjustment problems, preferring IB over EB, governments did not want to adjust exchange rates. (4)
A

In case of BoP disequilibrium governments were reluctant to:
- Devaluate: sign of governmental weakness
- Revaluate: loss of economic growth
- Contractionary policies: fear of unemployment
- Expansionary policies: fear of inflation.
-> IB over EB

76
Q

ERM crisis (1992-1993) (5)

A

1) Often weak fundamentals
*Increased interest rate r due to German unification
*Recession and fiscal deficit in Europe: no IB -> policy dilemma
- Capital mobility
- Speculators realized dilemma sold other currencies and bough DM

2) Event that possible triggered the crisis.
- Danes rejected Maastricht treaty, also likely in France -> forex tensions.

3) Big bang (break down of peg) Speculation attacks.
- CB respondent (forex intervention) but eventually several pegs collapsed, and bands widened to +/- 15%

4) IMF does not avoid crisis just limits impact.
- IMF passive

5) Spillovers to other countries
- Crisis spread to most ERM countries

76
Q

BW exchange rate system broke down and changed to floating regime (1970s) (3)

A
  1. August 1971: US would no longer sell gold to foreign CB for dollars and 10% import tariff.
  2. December 1971: Dollar devaluation to gold; other currencies also revaluated
  3. February 1973 -> establishing of floating system
77
Q

Commonalities of currency crises (5)

A

1) Fundamentals before crisis: Often weak fundamentals, combined with capital mobility.
2) Events that triggered the crisis: Sudden switch market sentiment
3) Big bang: CB loses against speculators: peg collapses.
4) Role of IMF: IMF does not avoid crisis just limits impact.
5) Spillovers to other countries: Regional or even world-wide impact.

78
Q

Mexico (1994 – 1995) (5)

A

1) Fundamentals before crisis:
- Current account and fiscal deficits
- Capital mobility

2) Events that triggered the crisis:
- Capital outflows

3) Big bang:
- Forex intervention, devaluation of peso, followed by float

4) Role of IMF: IMF does not avoid crisis just limits impact.

5) Spillovers to other countries: Regional or even world-wide impact.

79
Q

East Asia (1997-1998) (5)

A

1) Fundamentals before crisis:
- No serious current account and budget problems
- Structural problems: public guarantees for investment, poor evaluation of risk-return
-> moral hazard & adverse selection: unprofitable investments
- Capital mobility

2) Events that triggered the crisis:
- No specific event; maybe because Thai finance company could not pay its bills

3) Big bang:
- Thai baht and other currencies in regio fell

4) Role of IMF:
- IMF loans to several countries

5) Spillovers to other countries:
- Increased Thai competitiveness & risk reassessments caused problems in regio and developing countries.

80
Q

Pros of currency board (Argentina 2002) (3)

A

+ Central bank cannot expand the money supply much (discipline)
+ Govt isn’t allowed to sell bonds to CB to deficit -> fiscal discipline
+ Standard advantages or fixed exchange rates

81
Q

Cons of currency board (Argentina 2002) (3)

A
  • CB is unable to lend to banks in crisis
  • How to convince market that currency board will not be suspended
  • Standard disadvantages of fixed exchange rates
82
Q

Argentina crisis (2002) (5)

A

1) Fundamentals before crisis:
- Current account deficit (due to expensive dollar), fiscal deficit
- Recession
- Capital mobility

2) Events that triggered the crisis:
- Rumors about adjustment / suspension of currency board

3) Big bang: CB loses against speculators:
- Govt. restricted cash withdrawals, devalued peso, followed by float

4) Role of IMF:
- IMF loan

5) Spillovers to other countries:
- Regional impact (Brazil, Uruguay)

83
Q

How to limit currency crises (3)

A

1) Limiting capital mobility
2) Giving up your own currency (dollarization)
3) Using a fully floating exchange rate

84
Q

1) Limiting capital mobility (def)

A
  • Impose small tax for forex transactions to block short-term capital flows, however, it would reduce efficiency. The threat of speculators attack forces governments to more discipline.
85
Q

2) Giving up your own currency BENEFITS (dollarization)

A

+ No devaluation possible -> no speculative attacks
+ No currency risk -> Es° = 0 and reduces RP -> r lower
+ Standard advantages of fixed exchange rates

86
Q

2) Giving up your own currency DISADVANTAGES (dollarization) (3)

A
  • CB cannot buy H bonds to increase money supply
  • Loss of policy flexibility (what if recession buy r in us is high)
  • Fiscal deficits have to be financed by (dollar) bonds, not monetized
87
Q

Coordination of economic policies: (3)

A
  1. Exchange of information
    - Information’s are exchanged automatically such as views and future politics
  2. Mutually consistent policies
    - Countries adjust their objectives and tools with other countries.
  3. Joint action
    - Authorities could agree on joint action to achieve desired targets, some countries agree on mutual exchange rete targeting.
88
Q

Benefits of coordination: (3)

A

+ Reduction of uncertainty: More information available
+ Avoid excess inflation: Avoid competitive manipulation of the exchange rate.
+ Without coordination, countries are sometimes trapped in a bad equilibrium.

89
Q

Disadvantages of coordination: (3)

A
  • Cheating
    - Negotiations on the appropriate policy can be hard
    - If not, 1all countries gain from the coordination: how to compensate the losers.
90
Q

Spillover effects: (2)

A

a. Countries are connected via trade flow -> Changes in export and imports will change national income and employment levels.
b. International capital movements -> Freeing an economy from keeping its current account in balance. UIP conditions ties international exchange rate differentials.

91
Q

Severely indebted: (2)

A
  • Debt/GNP > 80% and/or - Debt/exports > 220%
92
Q

Characteristics Less-developed countries (LCDs) (5)

A
  1. Financial Markets
  2. Forex market
  3. Output and exports not much diversified
  4. High inflation
  5. Corruption
93
Q
  1. Financial Markets: (5)

Characteristics Less-developed countries (LCDs)

A
  • Controls banks
  • Forces low interest rate to stimulate investment Excess demand for funds
  • Borrow from abroad
  • External debt increases.

-> If markets are liberalized, then
- Weak institutions
- Lending to risky projects.

94
Q
  1. Forex market: Gov. pegs rate to reduce inflation. (4)

Characteristics Less-developed countries (LCDs)

A
  • Output and exports not much diversified
  • High inflation
  • Corruption
    -> Restrictions will always cause just more restrictions.
95
Q

Why capital flows to LDCs? (3)

A

LDC:
Poverty and weak financial institutions -> low savings

Low capital stock -> high marginal product of cap. -> high investments

Developed countries:

High capital stock -> low marginal product of capital -> search for profitable investment opportunities
-> lend to LDC

96
Q

Problem 1: not all lending is good (2)

A
  • Some investments are useless, or very risky
  • Sometimes loans just finance consumption
97
Q

Two main types of loans (2)

A

Debt finance (bonds, bank loans, official finance)
-> Debt service not lower if economy worsens

Equity finance (foreingn direct investment, buy shares of LDC firms)
-> Profits and dividends lower if the economy worsens

98
Q

Two Causes latin american debt crisis (2)

A
  1. Internal causes
  2. External causes
99
Q

Internal causes (4)

A
  • Low r, guarantess for banks, weak credit institutions
  • Money creation to finance gov. expenditure
  • Intervention in trade, exchange controls
  • Acceptance of floating interest rates on debt

-> Mainly governmnet failures

100
Q

External causes latin american debt crisis (3)

A
  • 1st oil shock (oil import became more expensive and global demand decreased; Oil countries invested in LDC, increased foreign debt and this made them vulnerable towards foreign debt)
  • 2nd oil shock (industrial countries decreased money supply and increased interest rates)
  • US policy (US president increased r of US and therefore the debt expense of LDC borrowing from US)
101
Q

12 August 1982 (def.)

A

Mexican govt. could no longer meet financial obligations of its 80 billion in foreing debt

-> Many LDC could no longer meet debt obligations
-> Debt crisis

102
Q

Crisis management can be split into 3 phases:

A

1) Crisis is viewed as a temporary liquidity problem
2) Try to grow out of debt problem
3) Crisis is viewed as a solvency problem.

103
Q

1) Crisis is viewed as a temporary liquidity problem

A

-> Reschedule debt repayments falling due to give debtors time

104
Q

2) Try to grow out of debt problem

A

-> Stimulate economic growth to reduce debt/ GDP

105
Q

3) Crisis is viewed as a solvency problem.

A

-> Forgive debt

106
Q

Lessons and links to crises in 2007 (6)

A
  • LDC govt. should reduce eco. control
  • Be cautious with borrowing under risk.
  • Banks must be careful with lending.
  • Umbrella organizations are useful.
  • Liquidity provision to buy time.
  • Debt forgiveness / bailout may help.
107
Q

Treaty of Paris (2)

A

1951
-> Established the European Coal and Steel Community

  • France proposed integration so that the german reconstruction does not endanger peace

(Belgium, France, Germany, Italy, Luxembourg, Netherlands)

108
Q

Treaty of Rome (2)

A

1957
-> European Economic Community (EEC): aiming at common market

-> European Atomic Energy Community (Euratom)

109
Q

European Monetary System (3)

A

1979

-> EMS: Exchange rate stability, Low inflation

*Also contain ERM (Exchange Rate Mechanism)

*Search for stable exchange rate regimes after the collapse of the Bretton Woods exchange rate regime

110
Q

Exchange Rate Mechanism (ERM) (2)

A
  • Exchange rate band (+/- 2.25%)
  • CB “borrows” credibility, market participants know that inflation would come at a high cost due to exchange rate band and therefore the expected inflation is low
111
Q

ERM (European exchange rate mechanism) crisis (2)

A

1992 - 1993

Speculators sold weak currencies, exploiting capital mobility

-> Bands widened to +/- 15% around parity as from 2 august 93

-> De facto end of ERM

112
Q

Why from EMS to EMU (4)

A
  • Single currency would enhance market integration
  • EMS became too asymmetric (Bundesbank focused on Germany (Internal Balance); non German CB followed Buba (external balance)
  • Capital mobility & “fixed” exchange rates
  • Steps towards political unification
113
Q

Economic and Monetary Union (EMU) (2)

A
  1. Economic union
    - Common market (free trade, common external regulations)
    - High coordination of economic policy (competition, macroeconomic, regional development)
  2. Monetary union
    - Total convertibility of currencies
    - Fully integrated financial marekts
    - Irrecovably fixed exchange rate
114
Q

Benefits of monetary union (MU) (2)

A
  1. Monetary efficiency gain
    -> Less uncertainty, confusion, transaction costs
  2. Improved monetary system
    -> Less reserves needed, CB is more powerful
115
Q

Costs of MU (2)

A
  1. Economic stability loss
    - asymmetric shock but no action at union level
    -> no room for monetary expansion and exchange rate policies
    -> Serious loss of policy autonomy
  2. Transaction costs
    - Adjustments of hardware, software …
116
Q

Definition OCA (def.)

A

Optimum currency area (OCA) is region where economic efficiency would be maximal if single currency were used

117
Q

Maastricht Treaty (3)

A

1991

  1. Defined timetable 3 stages to single currency
  2. Criteria of convergence of national economic performance
  3. U.K. negotiated an “opt-out” does not have to use the euro
118
Q

Criteria of convergence (EMU) (def. +3)

A

-> Ensure that economic development within EMU is balanced and does not
give rise to any tensions between the Member States.

They must enter stage 3 if they meet it

  • Low inflation (comparable to that of other members)
  • Low long-term interest rates
  • Government budget deficit <3% of GDP
  • Govt. debt < 60% of GDP (or tendency towards that: Belgian clause)
  • Within ERM for two years
119
Q

Stability and Growth Pact (SGP; 1997) (3)

A
  • Medium-term budgetary stance “close to balance or surplus”
  • Penalties if deficit > 3% of GDP

-> Control inflation

120
Q

ERM II (5)

A
  • Peg currency to euro
  • Asymmetric: countries must follow ECB policy

-> Discourage competitive devaluations against euro
-> Satisfying Maastricht treaty
-> Who will be next to join the euro?

121
Q

Greek tragedy: some causes (4)

A
  • High public debt/GDP when entering EZ
  • Low borrowing rates for Greece inside EZ
  • Credit crisis (world wide recession)
  • Structural problems
122
Q

European Stability Mechanism (ESM) (3)

A

2012

  • Intergovernmental organization headquartered in luxenbourg
  • It can lend to EZ members

-> Avoid speculators can make money by successful attack

123
Q

Motivation for banking union (3)

A

2012

Vicious circle
-> banks and governments are codependent and influence each other

F banks have H debt
-> Problems in H spill-over to F

International coordination can be beneficial
-> Bigger group of bailout supporters

124
Q

Banking union - SETUP (5)

A

2016

A: Single supervisory mechanism
-> ECB monitors largest banks & national supervisors remaining banks

B: Single resolution mechanism
- banking sector fills a fund
- Fund pays to rescue troubled banks

-> Cuts vicious circle for H country
-> Reduces spill-overs from H to F
-> Avoids that gov. and taxpayers must pay the bill

125
Q

Capital Market Union (def. +2)

A

2015

-> Improve investment & savings flows across the EU to firms & households,
regardless of where they are located

  • Greater choice of funding at lower cost
  • Lower the dependence on the banking sector
126
Q

Features of the euro system (3)

A
  1. Euro system (ECB and NCB)
  2. Objectives (price stability & support general economic policy)
  3. Independence from politics
127
Q

Formula real exchange rate

A

Sr = S (P*/P)

128
Q

Bipolar world in terms of exchange rate regimes

A

A: Fixed exchange rate (currency board)

B: Floating exchange rate

129
Q

Marshall-Lerner Condition: (3)

A

-> Currency devaluation improves the current account if ηx+ηm >1

  • Short Run: Condition often not met.
  • Long Run: Condition usually met.
130
Q

Demand elasticity < 1

A
  • Quantity demanded changes by smaller percentage than the change in price

-> Inelastic deamnd

131
Q

Exact Formula CIP

A

1+r = 1/S (1+r*) F

132
Q

Appreciation of exchange rate (def.)

A

Value of countrys currency increases relative to other currencies

Laurin (5 decks)

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