WEEK 11 - Optimum Currency Areas and the European Experience

Question 1

What did the Single European Act of 1986 recommend?

Answer 1

Many barriers to
trade, financial asset flows, and immigration be removed by December
1992.
It also allowed EU policy to be approved with less than unanimous consent among members

Question 2

What did the Maastricht Treat (1991) do?

Answer 2

-> Required the 3 provisions to transform the EMS into an econ and monetary union:
    It also required 
    standardizing regulations 
    and centralizing foreign 
    and defense policies 
    among EU countries.
     Some EU/EMS members 
     have not ratified all of the 
    clauses.
     Requires that members 
      that want to enter the
      economic and monetary 
      union

Question 3

The Maastricht Treaty requires that member that want to enter the economic and monetary union must:

Answer 3

1. Attain exchange rate stability defined by the ERM before adopting the
   euro.
2. Attain price stability; Max inflation of 1.5% above the avg of the 3 lowest national inflation rates among EU members
3. Maintain restrictive fiscal policy:
   - a maximum ratio of government deficit to GDP of 3%.
   - a maximum ratio of government debt to GDP of 60%
   (Fiscal Penalties on countries with excessive deficits or debts)

Question 4

What does the Stability and Growth Pact (1997) allow for?

Answer 4

Financial penalties on countries with excessive deficits or debt

Question 5

What did the ERM2 Establish?

Answer 5

=>It allowed countries (either within or outside of the EU) that wanted to enter the economic and monetary union in the future to maintain stable exchange rates before doing so.

=>It allowed EU members outside of the economic and monetary union to
maintain fixed exchange rates if desired.

Question 6

What are the benefits in the EU/EMS/Econ and Monetary Union?

Answer 6

=>High degree of
economic integration:
large trade volumes as a fraction of GDP
=>A large amount of foreign financial investment and foreign direct investment relative to total investment
=>a large amount of migration across borders as a fraction of total labor force

Question 7

What are the elements pertaining to employment and migration in the EU?

Answer 7

=>Regional migration is not extensive in the EU.

=>Europe has many languages and cultures, which hinder migration and
labor mobility.

=>Unions and regulations also impede labor movements between
industries and countries.

=>Differences of U.S. unemployment rates across regions are smaller and
less persistent than differences of national unemployment rates in the
EU, indicating a lack of EU labor mobility.

Question 8

Why does Capital Mobility without Labour Mobility make the econ stability loss greater?

Answer 8

There is evidence financial assets able to move more freely within EU (1992 and 99) -> But weak labour movement

=>After a reduction of aggregate demand in a particular EU country,
Financial assets could be easily transferred elsewhere while labour is stuck.
=>The loss of Financial assets could further reduce production and
employment.

Question 9

Why and how are structure of EU econ and monetary unions important to determine how members respond to AD shocks?

Answer 9

=>The economies of EU members are similar in the sense that there is a
high volume of intra-industry trade relative to the total volume.
=>They are different in the sense that Northern European countries have
high levels of physical capital per worker and more skilled labor, compared with Southern European countries.

Question 10

Why does the Euro face significant problems in the future?

Answer 10

=> Asymmetric economic developments within different countries of the euro zone (can call for dif interest rates) -> Makes hard for single monetary policy
=> Labour mkts highly unionised and subject to employment law and taxes that impede labour mobility
-> Leading to high lvls of unemployment (persistent)

Question 11

What are the 2 seperate models of banking?

Answer 11

• The Anglo-French

- German Model

Question 12

What are the elements and focuses of the Anglo-French model?

Answer 12

• The central bank pursue several objectives (Price Stability only one of the objectives and doesn’t get special treatment)
• Monetary policy subject to Govt Approval
• Political Dependence

Question 13

What are the elements and focuses of the German Model?

Answer 13

• Price Stability considered to be the primary objective of the Central Bank
• Monetary policy taken by Central Bank without interference of political authorities
• Political Independence

(THIS MODEL PREVAILED IN DESIGN OF ECB)

Question 14

What are the statutes of the ECB (Focusing on the Objectives)

Answer 14

• > Maintenance of Price Stability (Article 105)
• > ‘Shall support the general econ policies in the community with a view to contributing to the achievement of the Community as laid down in article 2 (Article 105 (1))

Question 15

What are the statutes of the ECB (Focusing on Political Independence)

Answer 15

-> ‘Shall not seek nor take instructions from community institutions or bodies from any govt or member state or from any other body’

Question 16

Why has the German model prevailed in the design of the ECB?

Answer 16

intellectual development, i.e. the monetarist counter revolution
strategic position of Germany in the process towards EMU

Question 17

FULL EXPLANATION OF WHY THE GERMAN MODEL HAS PREVAILED

Answer 17

=>In order to accept EMU, the German monetary authorities insisted on
having an ECB that gives an even higher weight to price stability than the Bundesbank did.
=>This victory was greatly facilitated by the fact that most central
bankers had been converted to monetarism.
=>Creation of ECB was dominated by fear of inflation bias.
=>This led to idea that ECB should be conservative, i.e. given overriding importance to price stability neglecting output and unemployment stabilization if necessary

Question 18

What does the Eurosystem consist of and what are the governing bodies?

Answer 18

Eurosystem:

• ECB
• National Central Banks of Member states

Governing Bodies:

• Exec Board (Pres,VP,4 Directors of ECB)
• Governing Council (6 members of Exec Board of the 12 national CB’s)

Question 19

WHAT DOES THE FRAMEWORK OF THE ECB LOOK LIKE

Answer 19

SEE GRAPH IN NOTES -> SEE LECTURE NOTES

Question 20

WHAT DOES THE SYSTEMIC RISK BOARD OF EUROPE LOOK LIKE (STRUCTURE-WISE)

Answer 20

SEE GRAPH IN NOTES -> SEE LECTURE NOTES

Question 21

What are the 4 key criteria that ensures a stable OCA?

Answer 21

Mundell (1961) came up with 4 key criteria:

1. High Labour mobility
2. Capital Mobility and wage flexibility to allow for even distribution of flows of labour and to dampen economic shocks.
3. A currency risk-sharing or fiscal mechanism that shares risk via transferring money from countries with a budget surplus to those with a deficit.
4. Similar business cycles to allow for joint monetary policy