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spring - Lecture Notes for the Final[1]

spring - Lecture Notes for the Final[1] - Ec10 Spring 2006...

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Ec10 – Spring 2006 LECTURE SUMMARIES Prof Ardagna on Europe important Is Europe heading toward Argentina’s fate? - the “Devils” - globalization - the Right Explanations - science & technology - unions/labor markets - taxes/ regulation Lazy Europeans Questions: Will Europe experience the same destiny as Argentina? a. Comparison between the US and Europe US has experienced steady (and slightly increasing) growth over the past 25 years. Most European countries started out growing at a rate similar to the US in 1981, while today growth has slowed down a lot. GDP per capita in Europe has been falling relative to the US. Same trend can be seen in unemployment. In 1981, the unemployment rate in the Euro area was below the u rate in the US, while today it’s a lot higher than the US u rate. b. Why is Europe falling behind? 1. “The Devils” a. The Euro b. The ECB c. China d. FDI 2. The real problems a. Europeans work less b. Productivity c. Technology and Innovation d. Education e. Regulation f. Fiscal Policy composition g. Demographics and Immigration h. Financial markets i. Judicial Systems The Euro: 1
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1 Benefits of single currency: Facilitate trade by: 0 - Reducing transaction costs 1 - Increasing price transparency 2 - Reducing uncertainty due to exchange rate fluctuations Stabilize inflation by: 0 - Delegate monetary policy to a more conservative central bank (ex. Before the EU, Italy would print money in order to finance government spending which created inflation; now it can’t do that anymore) 1 - Solves the credibility problem (Recall that the central bank can say that it will stick to the goal of reducing inflation, but it is tempted to renege on its word because of the short-run trade-off between unemployment and inflation. In this case, each individual country doesn’t even have a central bank – so it has to go with whatever the ECB decides and can’t go back on its word.) 2 - Convergence of inflation rates and interest rates There are political benefits of a single Euro area 2 3 Costs of single currency: Loss of Monetary policy: 0 - Now, it is the ECB that decides on monetary policy for both, say, Germany and Italy. The problem might be that these two countries experience very different shocks. For example, Germany might be experiencing a boom due to favorable demand conditions, while Italy might be experiencing a recession due to something else. What should the ECB do: help Italy out by increasing money supply? But that would overheat the German economy even further causing inflation there. On the other hand, if the ECB raises interest rate to dampen the boom in German, it will send Italy into an even deeper recession. 1 - The only policy tool left for each individual country is fiscal policy, which might not always be an appropriate channel for battling recessions. 0
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