Topic list exam _3 - Fall 2009_1

Topic list exam _3 - Fall 2009_1 - A Ch.16 Exp B Optimum...

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A Exp. B Ch.16 Optimum Currency Areas (OCA) The impact of a shock : how it impacts a country on its own, asymmetric shocks in a currency area. Country On Own Shock will shift AD left, if nominal ER can depreciate new equilib will be met at lower point on AS (decrease in output) and real exchange rate will depreciate If ER is fixed output declines even more with a shift horizontally to new AD; over supply occurs until eventually production falls; recession gives incentive to cut prices and eventually economy shifts to equilib point of AS and new AD; real ER will depreciate relative to rest of world Country in Currency Area Common exchange rate cannot insulate all member countries Central bank can choose to favor “shocked” country or unaffected; both cases result in hurting one or the other If common external ER floats , it will depreciate to an intermediate level o excess supply for shocked o excess demand for unaffected o overtime shocked country goes into recession and disinflation (lower equilb on new AD), unaffected booms and inflation EX: If Italy is in recession: o And other eurozone members are too : ECB will lower interest rates increased investment, euro depreciates increased exports o And other eurozone members are not : ECB will not lower rates, bad for Italy How would a country adjust to shocks if not part of a currency union-how does being part of a currency union change this. Euro is floating, issue is that countries don’t get to choose rate What would a country do if not part of euro? Choices would be different Advantages and disadvantages to being part of a currency union Advantages o Currency convenience Advantage to potential joiners to attract outside business One currency between states so transactions are much easier o Price comparability Single currency makes prices much more comparable o Cross border investment Eliminates exchange rate risks so helps on part of the potential joiner as well as the existing country o Inflation discipline o Exchange rate discipline o Lender of last resort
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o Expertise o Political union Disadvantages o Gives up the opportunity to select a monetary policy which a country deems optimal for itself o Country’s exchange rate cannot respond to the market forces by which changes in technology, taste, and the behavior of other countries affect its international competitiveness Criteria for being an OCA Asynchronous Business Cycle o Have boom and bust periods at the same time o Important because there is only one monetary policy Asymmetric Shock o can cause asynchronous business cycles o reliance on one industry can cause this Diversification of Production o Can help avoid asymmetric shocks o Most w.european countries are well diversified Mobility of K and L o low labor mobility in W.Europe because of language and culture differences Openness o how much do prices reflect/adjust to exchange rates o Essential to maintaining competitiveness of exports
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Topic list exam _3 - Fall 2009_1 - A Ch.16 Exp B Optimum...

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