Costs of Common Currency

What is Asymmetric shock with common shock

countries have same shock but with very different magnitudes

Why is labour mobility low in the EU

• differing pension systems

• unemployment benefits

• language

What are the main mechanisms to absorb Asymmetric shocks in monetary union

• wage flexibility

• labour mobility

How does Wage flexibility lead to asymmetric shock being absorbed by Monetary Union

french workers reduce wage claims shifting AS out

German workers raise wage demands shifting AS in

How could countries outside of a Union combat shock if they occured

• If flexible forex rates then change interest rates

• if fixed rates then revalue the currency

What is a public insurance system

• system which transfers money between countries of a union after being affect by shock

What is risk of Public Insurance system

susceptible to moral hazard

What are other sources of Asymmetry

• Different labour market institutions

• Different legal systems

• Different growth rates

What can occur with symmetric shocks in monetary independence?

beggar my neighbour policies

What is the equation of Phillips curve in Barro gordon

U = Un + a (inflation expectations - actual inflation)

Barro Gordon Central theme

• how lack of credibility can lead to higher inflation through inflation expectations

What is a beggar my neighbor policy

• policies which benefit your economy but hurt close neoghboours e.g tarriffs

Public insurance alternative: flexible national budgets

• france faces recession issues bonds

• Borrows in capital markets from german investors whose economy is booming

• In future French have to pay back borrowing

What is the caveat with flexible national budgets used as insurance

• debt accumulation can become unsustainable if country becomes credit risk

What are some further OCA criteria

• product diversification

• Homogenous prefrences

• Solidarity

Adjustment Mechanism in the absence of labour mobility

• germany higher demand for labour

• wages rise

• Higher cost of production and so price of german goods rise

• french goods regain competitiveness

• French exports rise boosting aggregate demand

Chain for labor mobility and how it prevents effects of Asymmetric Shock

• High unemployment in france in recession

• french workers move to demand filled Germany for work

• higher wage pressure in France

• income and demand recover

Chain from lower interest rates or devalued currency

• Independent France lowers interest rate

• depreciation of french currency and appreciation of German

• french products are therefore cheaper and so exports rise

• Currency is devalued by interest rate as capital flows out of France as people sell francs for German bonds driving currency value down

Critique of OCA theory three levels

• should we worry about asymmetric shocks in highly integrated areas

• is national monetary policy effective

• How credible are national monetary policy

• should we worry about asymmetric shocks in highly integrated areas

2 main views Krugman and EU Commission view

Krugman View of asymmetric shocks

economies of scale lead to agglomeration effects, which lead to more asymmetric shocks

• industries bunch together in certian areas e.g german automotive

• shock crisis like 2008 becomes highly asymmetric

Critique of Krugman

agglomeration effects can occur cross borders in this case national monetary policy will not be effective

Commision View

countries trade more with the same industry and so economies become similarly structured over time, reducing the number of asymmetric shocks

What is an issue with nation states

They are a source of asymmetric shocks due to budgetary power

De Grawe key conclusion on effectiveness of national monetary policy

• interest rate changes have a low effect due to capital mobility

• Highly integrated financial markets exchange rate movements could be volatile and not policy-driven

• Credibility could be diminished

Indifference curves barrow gordon model

showcase how much a country values fighting unemployment vs fighting inflation

Hard nosed definition

attaches a lot of weight to fighting inflation

Wet nosed deifinition

attach a lot of weight to fighting unemployment