Optimum Currency Areas and the Euro-zone

Question 1

OCA definition

Answer 1

An Optimum Currency Area is an economic region which would maximise economic efficiency to have the entire region share a single currency.

Question 2

EMU definition

Answer 2

An Economic Monetary Union is when two or more groups share a common currency, often having a main central bank which sets fiscal policies.

Question 3

ECB (2008) - state of the Eurozone

Answer 3

the fundamentals of “The euro area
economy remain sound and the euro area does not suffer from major
imbalances”.

Question 4

Optimum Currency Area Theory definition

Answer 4

Attempts to compare cost and benefits of countries forming an MU to judge whether they would loose or gain.

Question 5

Outline the main OCA criteria

Answer 5

Trade Openness
Factor Mobility (labour and capital)
Risk sharing mechanisms
Product diversification
Homogenous preferences

Question 6

Outline the OCA criteria labour mobility.

Answer 6

Mundell (1961)

Creates a single labour market by removing legal barriers and homogeneity of institutional contracts.

Question 7

Labour Mobility effects

Brinke and Dittrich (2016)

Answer 7

Movement from areas of low unemployment to high unemployment areas.
Labour mobility shifts fiscal pressure such as benefits and welfare statistics.
Wages help the fiscal situation of individuals relatives in their native countries.
Two countries example.

Question 8

Outline the OCA criteria capital mobility.

Answer 8

Mckinnon (1988)

Allows the allocation of resources across countries through supply and demand of market forces.

Question 9

What are the effects of effective capital mobility on a MU?

Answer 9

Removes exchange rate premiums between member states.

Removes potential gain from asymmetric shocks.

Question 10

Outline the OCA criteria risk sharing mechanism.

Answer 10

Redistributes wealth achieved through taxation by an EMU bank.

Question 11

Outline the OCA criteria homogeneous preferences and similar business cycles.

Answer 11

Cyclical booms and busts must have a relationship throughout member states to ensure that a central bank can implement uniform monetary policies.

Question 12

What are the effects of having greater specialisation in a MU?

Answer 12

Affected by a negative shock.

Countries become more product dependent.

Question 13

Jager and Hafner (2013)

Answer 13

Product diversification and limited specialisation which will reduce the impact of negative asymmetric shocks.

Question 14

Barslund et al (2015) - Labour mobility EU

Answer 14

Less than 3% of EU nationals reside in another EU member state

Question 15

Kapoor and Coller (2014) - EU Debt

Answer 15

Some Southern EMU countries debt to double between 1980 and 2010

Question 16

Baldwin and Giavazzi (2015)

Answer 16

Eurozone has been consistently higher when measuring exports and imports in percentage of GDP than the US

Question 17

Lane (2013)

Answer 17

5% fall in capital flows following the GFC.

Question 18

Outline the Maastricht criteria

Answer 18

Inflation rate not higher than 1.5% plus the lowest inflation rate in EU
Government budget deficient must not exceed 3%
Government debt to GDP ration must not exceed 60%.
No more than 2% than the average bond yields.

Question 19

Mogelli et al. (2016) - Specialisation EU

Answer 19

evidence for an overall Increasing specialisation across most member countries

Question 20

Outline the effects of devaluations to correct for asymmetric shocks.

Answer 20

Shifts demand and supply upwards.
Supply shift expansionary output effect of revaluation is reduced.
Increased inflation.
Open economies suffer more.
Effectiveness of exchange rate policy to correct for demand shocks is reduced.

Question 21

US labour mobility trends

Answer 21

A general reduction in interstate and same state migration.

Question 22

Gross migration EU compared to US (2000-2010)

Answer 22

Us is consistently higher migration rates.
2010 figures:
US 20 per 1000 residents
EU 3 per 1000 residents

Question 23

Degree of US interstate transfers (2004 to 2013)

Answer 23

Increase in net recipients in interstate transfers.

Reduction in net contributors.

Question 24

What is the SGP?

Answer 24

Stability and Growth Pact
An agreement, among the 28 member states of the European Union, to facilitate and maintain the stability of the Economic and Monetary Union (EMU)

Question 25

What are the main principles of the SGP

Answer 25

Achieve balanced budgets Budget deficit > 3% of GDP. Drop in GDP is between 0.75 and 2% the application of the fine

Question 26

Outline the SGP evaluation

Answer 26

ECB takes passive view on fiscal policy. Unbalanced in enforcing rules in place. Lack of budgetary flexibility to face recessions creates a potential for tensions between national governments and European institutions. Lack of flexibility of national budgetary policies in the EMU creates risks that could be larger than the risks of default and bailouts stressed by the proponents of rules.

Question 27

What are the possible imbalances in the Eurozone?

Answer 27

Current account (surplus in the north and deficit in the south) Wages/labour cost divergence. Inflation divergence. Differences in labour market institutions. Budget deficit and debt divergence.

Question 28

Outline the Lucas Paradox

Answer 28

Private capital flows from the higher regions to poorer regions.

Question 29

Trends of Lucas Paradox before the crisis

Answer 29

CA surpluses in North EU, deficits in South | and private capital flows North to South EZ

Question 30

Average current account balance (1999-2007)

Answer 30

Northern regions consistently running CA surplus of % of GDP. Opposite in South.

Question 31

Nominal Unit Labour Costs trends (1995 to 2008)

Answer 31

Across all EZ countries unit labour costs increase. Exception is Germany where it stays stable

Question 32

What is the Taylor rule?

Answer 32

Suggests that interest rates should be increases when inflation is above target or when GDP growth is too high.

Question 33

Comparison of US and EZ trends to the Taylor rule.

Answer 33

US: general trend with FED Target Rate between all regions. UZ: Divergence after 2008, southern regions well below target and northern regions above target.

Question 34

Outline the misallocation within sectors that can occur.

Answer 34

``` Politics: barriers to entry and constraints on growing firms without foreign competition. Politicians are receptive to small firms as entrepreneurship is seen as income mobility and small firms employ a large share of the population. Finance: underdeveloped financial markets may lack managerial talent and tools to diversity their credit portfolio. Give large loans to a few firms. ```

Question 35

Outline the misallocation across sectors that can occur.

Answer 35

Certain sectors protected by politicians. Lack of competition form local cartels. Certain sectors favoured by bankers. In construction collateral is available and easy to price.

Question 36

Evidence for misallocation in the EZ pre crisis.

Answer 36

Pre-crisis low interest rates fuelled by capital inflows. Southern European economies boomed. Wages and prices rose – but often less in manufacturing. Economic growth, but productivity performance patchy

Question 37

GIPS borrowing trends

Answer 37

Total lending from core countries to GIPS increased by 495% from 1999 to 2009.

Question 38

What is the diabolic loop?

Answer 38

In a liquidity crisis investors raise their perceived risk of default of government bonds. Increase interest rate, bond bonds are now worth less. Loss amplied by liquidity spirals. Less lending lowers economic activity which lowers tax rev and raises spending through automatic stabilisers. Government finances deteriorate.