EU306 lecture slides4 - Decision-Making The logic of...

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Decision-Making The logic of regional currency calls for a single central agency with strong supranational powers Fully Dollarized countries cede all powers to the central bank of the country whose currency they use - The relationship is hierarchial - No guarantee that the anchor country will take their views into account when decisions are made For instance, ECB and ECCU’s central bank ECCB is based on a principle of parity, relationship of equals but the central bank still has the final say
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Decision-Making (cont.) Near-dollarized countries have monetary agencies but without significant powers Currency Board countries have less demanding rules which give them more discretion (not entirely one-sided)
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Costs vs. Benefits Economic Factors 1. Transaction Costs (favors currency regionalization) Reduction in transaction costs in regionalization Expenses related to searching, bargaining, uncertainty and enforcement of contracts, currency conversion and hedging no longer needed Trade could increase Leads to efficiency gains Also leads to economies of scale of using a single currency 1. Reduction in administrative costs because a separate structure is no longer needed for a separate currency 2. A firmer financial sector is established (stability) – no big price ups and downs or currency revaluations 3. Reduction in interest rates for local borrowers
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Economic Factors (cont.) 1. Macroeconomic Stabilization (does not favor currency regionalization) - The loss of autonomous monetary policy to manage the economy - Governments give up control of money supply and exchange rate policy to cope with domestic or external disturbances 2. Distribution of Seigniorage (does not favor currency regionalization) - Spending power that accrues from the state’s ability to create money - This is a pure profit of the central bank - In regionalization governments either give this up completely or divert it to a joint institution
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Costs vs. Benefits (cont.) Political Factors 1. Social Symbolism (does not favor currency regionalization) Money plays a powerful role in helping to promote a sense of national identity Also has a psychological value Most communities have an emotional attachment to their currencies This would be compromised in terms of regionalization
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Political Factors (cont.) 1. Diplomatic Influence (does not favor currency regionalization) Money is command over real resources If a nation can be threatened with denial of access to the means of acquire goods and services it will be vulnerable in geopolitic terms Monetary sovereignty enables policy makers to avoid dependence on some other source for their purchasing power
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Costs vs. Benefits (cont.) Taking all five factors into account there are two implications - It is clear why so many states still want to produce their own money Reduction in transaction costs, on its own, would seem unlikely to outweigh the other factors - It is evident why there is such wide variation in the
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EU306 lecture slides4 - Decision-Making The logic of...

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