Regional Economic Integration: Levels, EU, Trade Agreements & Currency Markets

Regional economic integration

Regional economic integration

An agreement among countries in a geographic region to reduce or remove barriers to trade and investment.

Levels of economic integration

Free trade area, customs union, common market, economic union, and political union.

Free trade area

A free trade area eliminates tariffs and quotas among members while each country maintains independent external trade policies.

Rules of origin

Determine which goods qualify for preferential treatment within a trade bloc.

Customs union

Removes trade barriers among members and adopts a common external trade policy.

Common market

Allows free movement of goods, services, labor, and capital.

Economic union

Combines a common market with harmonized economic and monetary policies.

Political union

Coordinates economic, social, and foreign policies under a central authority.

Trade creation

Happens when lower-cost imports from a member replace higher-cost domestic production, increasing efficiency.

Trade diversion

Occurs when lower-cost imports from outside the bloc are replaced by higher-cost imports from member countries.

European Union (EU)

A political and economic union of 27 nations promoting regional integration through a single market and currency.

Treaty of Rome

The 1957 Treaty of Rome established the European Economic Community, leading to the creation of the EU.

European Commission

Proposes and enforces EU laws and policies.

European Council

Represents member states' governments and defines EU policy direction.

European Parliament

The elected body that debates and approves EU legislation.

Treaty of Lisbon

The 2009 Treaty of Lisbon reformed EU institutions and expanded the Parliament's power.

Court of Justice of the EU

Interprets EU law and ensures its equal application across member states.

Maastricht Treaty

The 1992 Maastricht Treaty formally created the EU and introduced the euro.

Optimal Currency Area

A region where adopting a single currency is economically beneficial due to similar structures and policies.

Brexit

Brexit was the UK's withdrawal from the EU in 2020 over sovereignty and immigration concerns.

EU-UK Trade and Cooperation Agreement

The post-Brexit trade deal between the EU and UK, allowing zero-tariff and zero-quota trade with new customs checks.

NAFTA

The North American Free Trade Agreement (1994) created a free trade area among the U.S., Canada, and Mexico. Replaced by the USMCA.

USMCA

The 2020 U.S.-Mexico-Canada Agreement updated NAFTA, increasing auto content requirements and labor protections.

Andean Community

A South American trade bloc including Bolivia, Colombia, Ecuador, and Peru.

Mercosur

Mercosur is a South American trade bloc (Argentina, Brazil, Paraguay, Uruguay) promoting free trade. Venezuela is suspended.

CAFTA

The Central America Free Trade Agreement links the U.S. and several Central American countries to promote trade.

CARICOM

CARICOM is the Caribbean Community of English-speaking nations promoting regional cooperation.

Caribbean Single Market and Economy (CSME)

The CSME aims to create a single economic space modeled on the EU.

ASEAN

The Association of Southeast Asian Nations promotes economic and political cooperation in Southeast Asia.

foreign exchange market

The foreign exchange market is a global network for exchanging one currency for another and managing currency risk.

spot exchange rate

The rate at which one currency is exchanged for another immediately, determined by supply and demand.

forward exchange rate

An agreed-upon rate for exchanging currencies in the future (30, 90, or 180 days). Used to hedge against exchange rate risk.

currency swap

A simultaneous purchase and sale of a currency for two different value dates, used to manage risk.

major foreign exchange trading centers

London, New York, Tokyo, Zurich, and Singapore are the largest forex trading centers.

arbitrage

Arbitrage is buying currency in one market and selling in another to profit from price differences.

law of one price

Identical goods should sell for the same price in different countries when expressed in a common currency.

Purchasing Power Parity (PPP)

states that the exchange rate should equalize the price of identical goods across countries. Example: Big Mac Index.

currency fluctuations

Exchange rates change due to inflation, interest rates, political events, and market speculation.

Fisher Effect

The nominal interest rate equals the real rate plus expected inflation.

What is the International Fisher Effect?

Currencies with higher nominal interest rates are expected to depreciate due to higher inflation expectations.

Higher nominal interest rates

Currencies with higher nominal interest rates are expected to depreciate due to higher inflation expectations.

Types of currency convertibility

Freely convertible, externally convertible, and nonconvertible currencies differ in how easily they can be exchanged for foreign money.

Capital flight

Capital flight occurs when investors quickly convert domestic currency to foreign currency due to instability.

Countertrade agreements

Countertrade involves barter-like deals used when currency is nonconvertible.

Transaction exposure

measures how currency changes affect specific financial obligations.

Translation exposure

assesses the impact of currency fluctuations on financial statements.

Economic exposure

measures how exchange rate changes affect a firm's future earning power.

International monetary system

consists of policies and institutions governing exchange rates between countries.

Gold standard

A system where countries pegged their currencies to gold ensuring convertibility and limiting inflation.

Bretton Woods system

A post-WWII fixed exchange rate system managed by the IMF, replaced by floating rates in 1973.

IMF

The International Monetary Fund promotes financial stability and provides loans to countries facing balance-of-payments issues. It was established in 1944 under the Bretton Woods Agreement.

World Bank

The World Bank funds long-term development projects in poorer nations to encourage economic growth.

Jamaica Agreement

The 1976 agreement that formalized floating exchange rates and abandoned gold as a reserve asset.

Managed float (dirty float)

A system where governments occasionally intervene to stabilize exchange rates. Example: China.

Pegged exchange rate

A currency fixed relative to a major currency like the U.S. dollar.

Dollarization

Dollarization occurs when a nation adopts another country's currency (e.g., Ecuador uses USD).

Currency board

A currency board fixes the exchange rate by backing domestic currency with foreign reserves.

Banking crisis

When confidence in the banking system collapses, causing mass withdrawals.

Inflation

general rise in prices caused by excessive money supply, demand pressures, or rising production costs.

Fixed exchange rate

An exchange rate maintained at a specific value by government intervention.

Examples of regional economic integration

Four examples include: 1) The European Union (EU) - the most advanced model; 2) The United States-Mexico-Canada Agreement (USMCA); 3) Mercosur in South America; and 4) The Association of Southeast Asian Nations (ASEAN).

Primary purpose of regional economic integration

The main purpose of regional economic integration is to improve free trade within regional borders by reducing tariffs, quotas, and trade barriers.

Currency

Currency is the system of money used in a country for transactions and trade. It serves as a medium of exchange, a unit of account, and a store of value.

Minimizing currency fluctuations

Countries can minimize currency fluctuations by pegging their currency to a stable foreign currency like the U.S. dollar, using a managed float system, maintaining monetary discipline, and building foreign exchange reserves.

Foreign exchange network

A foreign exchange network is a global system of banks, brokers, and traders connected electronically that operate 24 hours a day to trade currencies.

Impact on Purchasing Power Parity

Purchasing Power Parity is impacted by inflation rates, productivity, and government intervention.

Increasing currency supply

If a country increases its money supply faster than its economic output, inflation occurs. This lowers the currency's value and reduces purchasing power.

IMF loan repayment expectation

Yes, the IMF expects countries to pay back their loans.

Trade balance

A trade balance is the difference between a country's exports and imports of goods and services. A positive balance is a surplus; a negative balance is a deficit.

Current account

The current account records a country's imports, exports, income from investments, and transfers like remittances. It shows whether a country is a net lender or borrower.

Trade deficit

A trade deficit occurs when imports exceed exports, meaning more money leaves the country.

Trade surplus

A trade surplus occurs when exports exceed imports.

Sovereignty concerns in the EU

Some member nations fear loss of national control due to shared decision-making within EU institutions, leading to the UK's exit (Brexit) from the EU in 2020.

Causes of inflation

Inflation is caused by: 1) Excessive money supply growth, 2) Increased demand (demand-pull inflation), and 3) Rising production costs (cost-push inflation).

Predicting foreign exchange rate

No, exchange rates cannot be accurately predicted in the short term due to market speculation, inflation changes, and political events.

Managed float

Managed float (dirty float): government intervenes occasionally to stabilize currency.

Free float

Free float: currency value is set by market forces.

Currency crisis

happens when a currency's value drops sharply due to speculation or loss of confidence.

Foreign debt crisis

A foreign debt crisis occurs when a country cannot meet its external debt obligations.

Floating exchange rate

A floating exchange rate is determined by market forces of supply and demand without direct government control.