Chapter 4: Costs and Benefits Compared - PowerPoint PPT Presentation

About This Presentation
Title:

Chapter 4: Costs and Benefits Compared

Description:

... than in Eurozone Is Latin America an optimal currency area? Monetary instability has made the idea of ... in Africa There is a history of monetary ... – PowerPoint PPT presentation

Number of Views:158
Avg rating:3.0/5.0
Slides: 34
Provided by: Grim159
Category:

less

Transcript and Presenter's Notes

Title: Chapter 4: Costs and Benefits Compared


1
Chapter 4Costs and Benefits Compared
  • De Grauwe
  • Economics of Monetary Union

2
Costs and benefits of a monetary union
Benefits
Costs and Benefits ( GDP)
Costs
Trade ( GDP)
3
Two views about costs and benefits of MU
(a) The monetarist view
(b) The Keynesian view
Benefits
Benefits
Costs and benefits
Costs and benefits
Costs
Costs
T
T
Trade ( GDP)
Trade (GDP)
4
Two views about costs of MU
  • The 'monetarist view
  • Monetary policies are ineffective as instruments
    to correct for different developments between
    countries
  • The cost curve is close to the origin
  • Thus, many countries in the world would gain by
    relinquishing their national currencies, and by
    joining a monetary union

5
  • The 'Keynesian' view
  • The world is full of rigidities
  • Monetary policy (including exchange rate policy)
    is a powerful instrument in eliminating
    disequilibria
  • The cost curve is far away from the origin
  • Relatively few countries should find it in their
    interest to join a monetary union

6
  • Since the early 1980s the 'monetarist' view has
    gained adherents, and has changed the view many
    economists have about the desirability of a
    monetary union
  • The popularity of monetarism helps to explain why
    EMU became a reality in the 1990s

7
Costs and benefits with decreasing rigidities
  • With decline in wage and price rigidities and an
    increase in labour mobility
  • Cost curve shifts downwards
  • Monetary union becomes more attractive

Benefits
Costs and benefits
Costs
T
T
Trade ( GDP)
8
Is EMU an optimal currency area?
  • In order to answer to this question there are
    different parameters to evaluate
  • Intra-EU trade
  • Degree of rigidities
  • Degree of asymmetry of shocks

9
Table 4.1 Intra-union exports of EU countries (
of GDP) in 2005
  • Large differences in openness of EU countries
    with the rest of the Union
  • For countries with a small degree of openness (UK
    and Greece), it is less clear that they belong to
    an optimal currency area with the rest of the EU
  • Cost-benefit analysis is likely to show net
    benefits of being in EMU for Benelux, and small
    central European countries

10
Asymmetric shocks and labour market flexibility
  • Not only the degree of labour market flexibility
    which matters for determining whether a monetary
    union will be attractive to countries
  • Also asymmetry in demand and supply shocks
    matters
  • There is a link between labour market flexibility
    and asymmetric shocks in a monetary union

11
Asymmetric shocks and labour market flexibility
in monetary unions
  • Downward sloping OCA-line shows minimum
    combinations of symmetry and flexibility that
    countries must have in order for a monetary union
    to provide more benefits than costs
  • Countries or regions located below the OCA line
    do not have enough flexibility given the level of
    symmetry they face
  • Countries to the right of the OCA line have a lot
    of flexibility given the level of symmetry they
    face
  • Evidence about how many countries in EU form OCA
    is not clear-cut
  • Eurozone

Symmetry
  • USA
  • EU-25

OCA
Flexibility
12
  • The challenging task for the EU-25 is to move to
    the other side of the OCA-line, i.e. to make a
    monetary union less costly
  • How can this be achieved? There are essentially
    two strategies
  • Reduce the degree of real divergence (political
    union)
  • Increase the degree of flexibility of labour
    markets

13
Case-study
  • During the early 1980s the industrial world was
    hit by a severe recession
  • Two examples
  • Michigan in the USA
  • Belgium in Europe
  • Both regions are of a comparable size
  • Unemployment increased significantly more in
    Michigan and Belgium than in the USA and in
    Europe, respectively.

14
  • How did these two regions adjust?
  • In Michigan mainly outward migration
  • In Belgium mainly real depreciation
  • This helped to restore competitiveness, and
    started a process of gradual recovery leading to
    a significant narrowing of the unemployment
    differential between Belgium and the EC

15
  • Case-study suggests that even small countries
    like Belgium, for which the benefits of being in
    EMU probably outweigh the costs, have taken some
    risk
  • When in the future they will be subject to large
    shocks they will not have a national monetary and
    exchange rate instrument to soften the blow
  • As a result, given the rigidity of their labour
    markets, the adjustment to such large
    disturbances is likely to be painful

16
Costs and benefits in the long run
The European Commission view of monetary
integration
  • Upward sloping line (TT) because as trade
    integration increases the degree of symmetry
    between the countries involved declines
  • Downward sloping line (OCA)
  • Less symmetry makes a monetary union more costly.
    More integration reduces the costs of a monetary
    union. Thus a reduction in symmetry must be
    compensated by more integration to make a
    monetary union worthwhile (in terms of costs and
    benefits)
  • Points on OCA line are minimal combinations of
    symmetry and integration for which monetary union
    has zero net gain

T
Symmetry
EU-25
OCA
T
Trade integration
17
Costs and benefits in the long run
The pessimistic view of monetary integration
T
T
EU-25
Symmetry
T
OCA
T
Trade integration
18
  • Two possibilities for the long-term prospects of
    monetary union
  • One is represented by the TT line. In this case,
    although today the EU-25 may not be an optimum
    currency area, it will move into the OCA zone
    over time (right side of OCA)
  • The second case is represented by the steep TT
    line. Integration brings us increasingly farther
    away from the OCA zone. The net gains of a
    monetary union do not increase fast enough with
    the degree of integration. Thus, the costs of
    asymmetry overwhelm all the other benefits a
    monetary union may have
  • Second case is implausible

19
Endogeniety of monetary union
  • A decision by an individual country to join EMU,
    even if it does not satisfy the OCA criteria, can
    have a self-fulfilling character
  • In this case the process of integration is sped
    up by the very decision to join the monetary
    union, so that this new country grouping moves
    faster into the OCA zone
  • OCA becomes endogenous

20
The challenge of enlargement of EMU
  • Two challenges
  • Enlargement poses problems for the 12 present
    members
  • Enlargement poses problems for the newcomers

21
Is Euro-25 OCA? Openness as a criterion
Figure 4.11 Exports of goods and services
towards EU-25 as percentage of GDP (2005)
22
  • The central European countries are as open
    towards the EU as the EU-countries themselves
  • The central European countries appear to be more
    integrated with the EU than Denmark, Sweden and
    the UK

23
Is Euro-25 OCA? Asymmetry of shocks
  • Each point represents correlation between demand
    and supply shocks of particular country with
    EU-average
  • Many CE-countries demand shocks negatively
    correlated with EU demand shocks
  • Low correlation of supply shocks between
    CE-countries and EU
  • Asymmetries in demand shocks may disappear partly
    in MU, asymmetries in supply shocks more likely
    to stay

24
  • Thus, not all CE-countries may be part of an
    optimal currency area with the rest of the
    European Union
  • Despite relatively large openness of the
    CE-countries vis a vis the EU, many are subjected
    to relatively large asymmetric shocks, so that it
    is not obvious that they would gain from entering
    EMU
  • However, for some of these countries entering EMU
    might be the best possible way to import monetary
    and price stability

25
How will present members be affected by
enlargement to Euro-25?
symmetry
  • Euro-25 more subject to asymmetric shocks than
    Eurozone
  • Original members of Eurozone (who are also part
    of Euro-25) are thrown out of OCA-zone
  • Some original members will perceive policies of
    the ECB to be less receptive to their domestic
    shocks than prior to enlargement

Eurozone
OCA
EU-25
Economic integration
26
Should the UK join EMU?
  • Costs of a monetary union
  • Openness the UK has the lowest degree of
    openness towards the rest of the EU
  • Asymmetry of shocks demand shocks in the UK are
    negatively correlated with the demand shocks in
    Euroland
  • Flexibility there is greater flexibility in the
    UK labour markets than in the Eurozone (see the
    inflation-unemployment of the UK, France and
    Germany). Thus easier adjustment in UK than in
    Eurozone
  • It is unclear whether costs of monetary union are
    larger in UK than in Eurozone

27
(No Transcript)
28
Is Latin America an optimal currency area?
  • Monetary instability has made the idea of forming
    a monetary union in Latin America popular
  • Costs of monetary union in Latin America
  • Latin American countries have very low levels of
    trade with the rest of Latin America

29
Figure 4.16 Intraregional exports of goods and
services, EU and Latin America as a percentage of
GDP (2005)
30
  • Degree of synchronization of output movements is
    low in Latin America, and asymmetric shocks are
    relatively large
  • Very little empirical evidence has been
    undertaken to measure the degree of flexibility
    of labour markets
  • Main driving force for popularity of MU is the
    hope to import price stability
  • If monetary union comes about it will have to
    provide the right institutions guaranteeing price
    stability

31
Is East-Asia an optimal currency area?
Source IMF, IFS and Xu Ning(2004) Note the
exports of the East-Asian countries is to ASEAN
plus China, Korea and Japan. The data for China
relate to 2001.
32
Shocks are not more asymmetric in Asia than in
Eurozone
Eurozone
Asia
33
  • Economic conditions for monetary union in East
    Asia seem to be satisfied
  • Main stumbling block is political
  • Desire for political unification is weak
  • Contrast with Europe is great process of
    political unification in Europe has been going on
    since 1960

34
Monetary Unions in Africa
  • There is a history of monetary union in West- and
    Central Africa
  • Legacy of colonization CFA-zone
  • New initiative to extend existing monetary
    unions The Economic Community of West-African
    States (ECOWAS)
  • This is a grouping of 15 states
  • Do these form an OCA?

35
Figure 4.20 Intraregional exports of goods and
services in West-Africa (2003) and the Eurozone
(2005)
36
  • When using the Eurozone as a benchmark, the
    evidence on whether West Africa forms an optimal
    currency area is mixed
  • The degree of integration among West African
    countries is low, yielding relatively few
    benefits of a monetary union
  • Labour mobility is substantially stronger
  • The degree of asymmetry does not seem to be
    larger in West Africa than it is in the Eurozone
  • West African countries (the members of WAEMU)
    have already set into place a series of
    institutions, such as a common central bank
    facilitating further steps towards a monetary
    union

37
Conclusion
  • It is unlikely that the EU as a whole constitutes
    an optimal monetary union
  • As integration moves on, the number of countries
    that are likely to benefit from monetary union
    will increase
  • Enlargement of the Eurozone to 25 countries
    creates serious challenges
  • Euro-25 is probably not an OCA, but may become
    one
  • Enlargement will change the cost benefit calculus
    of existing members of the Eurozone. Some of
    these member countries may find out that the
    enlargement makes the monetary union less
    attractive

38
  • It is unlikely that Latin America and East Asia
    will come to monetary union soon, although
    reasons are different
  • Evidence about West-Africa as an OCA is mixed
  • Our analysis has been based on an economic
    cost-benefit analysis. Countries may also decide
    to adopt a common currency for political reasons
  • The economic cost-benefit analysis remains
    useful, because it gives an idea of the price
    some countries will have to pay to achieve these
    political objectives
Write a Comment
User Comments (0)
About PowerShow.com