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European Union Economics and International Institutions > Week three - the economic and monetary union > Flashcards

Week three - the economic and monetary union Flashcards

1
Q

what are the two methods to monetary integration

A
  • fixing the exchange rate and strong cooperation between national central banks
  • introduction of a common currency under a common central bank
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2
Q

what does the economic and montary union in the EU consist of

A
  • single monetary policy
  • single currency (euro)
  • close coordination of economic and fiscal policies
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3
Q

pros and cons of flexible (floating) exchange rate

A
  • allows for an independent monetary policy
  • protection of domestic economy from external shocks
  • provides automatic solution to external deficit
    BUT
  • created instability and uncertainty
  • encourages speculative activities
  • may be inflationary
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4
Q

pros and cons of fixed exchange rates

A
  • promotes international trade and investment
  • diminishes speculation
    BUT
  • inherently unstable
  • affects internal policy
  • requires large holdings of foreign exchange reserves
  • doesn’t allow for automatic balance of payments imbalances
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5
Q

how can inflation and unemployment spread from devaluation of currency

A
  • imports become expensive
  • companies may see their costs rising and may have to shift such rise to prices
  • workers see their standard of living fall and demand higher salaries
  • if salaries grow more than productivity, this may lead to unemployment
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6
Q

economic benefits of a currency area

A
  • transaction costs diminish
  • prices become comparable across countries (more competition)
  • uncertainty of ER diminishes
  • increase in trade
  • increase in growth rate
  • improved discipline and credibility of monetary policy both in the short and long-run
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7
Q

economic costs of a monetary union

A
  • asymmetric shocks increase macroeconomic instability
  • monetary policy loses autonomy (unless business cycles are synchronised and reactions to external shocks are similar/countries have similar tolerance towards inflation)
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8
Q

what is the optimal currency area theory

A

it considers the costs and benefits of a monetary union to determine if a number of countries is well-suited to share currency

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9
Q

what does an optimal currency area imply

A

total rigidity of exchange rates inside and full flexibility outside

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10
Q

why are countries better suited to share their currency

A
  • less costly
  • more beenficial
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11
Q

when can countires exploit the benefits of sharing a currency

A
  • when the countries are open to trade and trade heavily with each other
  • have production and exports widely diversified and of similar structure
  • have similar inflationary path and high degree of real convergence and coordinated economic policy
  • high degree of financial integration and free movement of capital
  • have labour mobility and wage flexibility
  • agree to compensate each other for adverse shocks (sharing a system of fiscal transfers)
  • share a consensus on how to deal with shocks
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12
Q

regarding the EMU, when faced with asymmetric shocks, what factors are missing to fulfill the criteria

A
  • flexibility in the labour market (wage and mobility)
  • a system of fiscal transfers
  • some heterogeneity among national preferences regarding economic policy
  • solidarity
  • leading to an uncertain result
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13
Q

what are the main reasons that prompted the creation of the EMU

A
  • political
  • economic: avoid the coexistence of four incompatible elements: full goods and services mobility, full capital mobility, fixed exchange rates, autonomous monetary policies
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14
Q

when was the first attempt to make the EMU

A

1970 - Werner report - failed

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15
Q

when was the EMU created and what exchange rate system did they use

A

1979, fixed but adjustable exchange rates

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16
Q

what is the delors report

A

it laid out the stages to create the EMU (1989)

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17
Q

what did the Maastricht treaty determine (1992)

A

the common currency should be created by 1999

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18
Q

what were the five entry conditions for the Maastricht treaty

A

convergence criteria:
- inflation (below a cieling)
- long-term nominal interest rates (ceiling and stable)
- stable exchange rates
- limited budget deficit (3% of GDP)
- limited public debt (60% GDP)

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19
Q

what is the stability and growth pact

A

1997: set conditions on the evolution of budget deficit (after entry) and procedures in case of failure

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20
Q

when was the ECB created

A

in 1998 (ecofin determined which countries filled the convergence criteria)

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21
Q

when were exchnage rates irrevocably frozen

A

1999 - national currencies ceased trading in foreign exchange markets, monetary policy was also transferred to the ECB

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22
Q

when were euro banknotes and coins introduced

A

2002

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23
Q

what is the european system of central banks composed of

A
  • ECB
  • NCBs (national central banks of all members)
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24
Q

what does the eurosystem composed of

A
  • ECB
  • NCBs of countries which have joined the monetary union
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25
Q

what body implements the monetary policy in the eurozone

A

eurosystem

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26
Q

characteristics of the ECB

A
  • independent of political authorities
  • high concentration of competency
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27
Q

exclusive powers of the eurosystem

A
  • implements monetary policy in the eurozone
  • holds and manages the eurozone official foreign-currency reserves
  • authorises central banks in eurozone countries to issue euro banknotes
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28
Q

shared powers of the eurosystem

A
  • exchange rate policy (with ecofin-19 and commission)
  • helps ensure financial markets and institutions are adequately supervised by national authorities, and that payment systems function smoothly
29
Q

what is the composition of the executive board of the EMU

A

president, vice-president, other members appointed by the European council, on a non-renewable term of 8 years

30
Q

what are the responsibilities of the executive board

A

implement monetary policy for the euro area following the decisions of the governing council

31
Q

composition of the governing council (main decision-making body)

A

executive board + governors of the national central banks of the euro area countries (minimum lenght of five years in office)

32
Q

responsibilities of the governing council

A
  • adopt the guidelines and make the decisions necessary to ensure the performance of the tasks entrusted to the Eurosystem
  • formulate monetary policy for the euro area
  • adopt decisions regarding the framework under which supervisory decisions are taken
33
Q

what are the voting rights of the governing council

A
  • executive board members hold permanent voting rights
  • governors belonging to the five largest economies in the eurozone share four voting rights
  • the rest of the governors share 11 voting rights
34
Q

composition of the general council

A
  • president and vice-presidents of the ECB
  • governors of the NCBs of member states
35
Q

responsibilities of the general council

A
  • contributes to the ECBs advisory and coordination work
  • helps prepare the new countries joining the euro
36
Q

what is meant by transitional body (general council)

A

it will be dissolved once all member states have introduced the single currency

37
Q

composition of the supervisory board

A
  • one chair and one vice chair and 4 ECB representatives of national supervisors
38
Q

responsibilities of the supervisory board

A

carries out the ECBs supervisory tasks

39
Q

what is the main goal of the Maastricht treaty

A

price stability in the long-term, defined as a year-on-year increase in the harmonised index of consumer prices (HICP)

40
Q

other objectives of the Maastricht treaty

A

support the general economic policies in the union

41
Q

what is the transmission mechanism of the monetary policy

A
  • the process by which the monetary policy decisions affect the economy in general and the price level in general
  • characterised by long, variable and uncertain time lags
  • the precise effects of the monetary policy on the economy and the price level are difficult to predict
42
Q

what are the two pillars of price stability

A
  • economic analysis (analysis of economic dynamics and shocks)
  • monetary analysis (analysis of monetary trends)
43
Q

what is the medium term

A

2-3 year horizon

44
Q

how does monetary policy operate

A

by steering short-term interest rates, and influencing economic developments in order to maintain price stability for the euro area over the medium term

45
Q

what are the operative variables of monetary policy

A
  • money supply (liquidity)
  • very short-term interest rates (EONIA - European over night index average), a weighted average of all overnight unsecured lending transactions in the interbank market
    OR - @Ester (euro short-term rate), a rate that reflects the wholesale euro secured overnight borrowing costs of euro area banks, investment and pension funds
46
Q

what are the instruments established by the ECB to control liquidity and interest rates

A
  • minimum reserve requirements for credit institutions
  • open market operations (four categories, most important is the main refinancing operations)
  • standing facilities to absorb or provide overnight liquidity, also known as discount window policy
47
Q

what are the two types of standing facilities

A
  • marginal lending facility: banks can obtain overnight liquidity
  • deposit facility: banks can make overnight liquidity, ( little incentive to use them as interest rates are unfavourable)
48
Q

what does an open market operation consist of

A

the purchase and sale of public debt bonds by the central bank which increases or decreases the liquidity of the financial system according to the needs of the economy

49
Q

what are the effects of each open market operation

A
  • increase interest rates: the higher the interest rate the higher the return, the more assets the banks have and thus less liquidity
  • reduction of interest rates have the opposite effects
  • sales of bonds by banks will decrease liquidity because they will spend their money on acquisition
  • purchase of bonds will have the opposite effect
50
Q

what does the ‘discount’ refer to

A

the discount rate is the interest rate at which the transaction is performed

51
Q

what are the two important roles of the discount

A
  • provides cash reserves when needed with little notice
  • facilitates monetary reserves when credit conditions worsen
51
Q

what are the two important roles of the discount

A
  • provides cash reserves when needed with little notice
  • facilitates monetary reserves when credit conditions worsen
52
Q

when do discounts become important

A

when there is a nervousness and lack of confidence in the financial system, this role is known as the lender of last resort

53
Q

what are most banks required to do in terms of reserves

A
  • keep money reserves in proportion to their customers’ deposits
  • these reserves guarantee a minimum liquidity and solvency in the system
54
Q

what is the monetary transmission mechanism

A

the route by which monetary policy affects output, employment, prices and inflation

55
Q

what are the steps of monetary transmission mechanism

A

1) CB raises the interest rate target based on the state of the economy
2) CB undertakes open-market operations
- to slow the economy, it would sell securities, reducing reserves and raising short-term interest rates
- if a recession threatened, the CB would buy securities, increasing the supply of reserves and lowering short-term interest rates
3) asset markets react to policy changes
- higher interest rates tend to reduce asset prices (stocks, bonds, houses) and tend to raise foreign exchange rates in a flexible exchange rate system
4) investment and other spending react to interest rate changes
- higher interest rates, tighter credit, lower wealth and higher exchange rate tends to reduce investment, consumption and net exports

56
Q

what are non-standard monetary operations

A

unprecedented measures in response to financial crises

57
Q

when did non-standard monetary operations become important

A

since autumn 2008 (financial crisis)

58
Q

what are some other measures used to support a financial crisis

A
  • improved system of financial supervision
  • financial assistance mechanisms or bail-outs
  • increased economic governance
  • reforms to increase competitiveness
59
Q

what are some concerns with monetary policies being common in the EU

A
  • too big budget deficits could affect stability in the eurozone
  • too much public debt could increase interest rates in the eurozone and put pressure on the ECB to buy public debt
60
Q

what is the stability and growth pact

A

a framework for coordination of national fiscal policies, there is prevention (countries submit stability programmes yearly) and correction (sanctions when rules are breached)

61
Q

why was the growth and stability pact discredited

A

france and germany failed repeatedly to comply with from 2001

62
Q

what was the aim of the lisbon strategy

A

to make the EU the most competitive and dynamic economy in the world capable of sustainable economic growth

63
Q

what were the five areas of targets of europe 2020

A
  • employment
  • R and D
  • climate change and sustainability
  • education
  • fighting poverty and social exhaustion
64
Q

who monitored Europe 2020

A

european semester

65
Q

what is the european semester

A

the EU’s annual cycle of economic and fiscal policy coordination

66
Q

what three blocks of economic policy coordination does the european semester cover

A
  • structural reforms
  • fiscal policies
  • prevention of excessive macroeconomic imbalances
67
Q

how did the financial crisis turn into a recession

A
  • american homeowners defaulted on their mortagages
  • spread to banks all over the world
  • bankruptcies started (banks stopped lending to each other)
  • intervention of CBs
  • recession hit in 2009
68
Q

what did the keynesian policies in 2008/9 lead to

A

budget deficits –> increase in public debt, fall in tax revenue and increasing spending on crisis-related expenses, higher doubt on the governments ability to pay their debts back, ultimately leading to the sovereign crisis

European Union Economics and International Institutions (5 decks)

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