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The benefits of a common currency

10 important questions on The benefits of a common currency

Via which two ways does a common currency entail gains in economic efficiency?

1. elimination of transaction costs associated with exchanging national moneys
2. elimination of risk coming from the uncertain future movements of exchange rates

What is the aim of SEPA?

Single Euro Payment Area. Aims to simplify and codify payment standards across the EU.

Describe the TARGET system

an interbank payment system for processing cross-border transfers through the EU. Since banks are required to provide collateral for each payment, risks that a bank default will have a domino effect is eliminated.

How does a common currency benefit consumers?

There is more price transparency, consumers can compare products easier, increases competition, benefiting consumers

Wolszczak-Derlacz (2006) find that price convergence happened before 1999, since the EU it has stopped. Studies show that the euro did not reduce price dispersion. What are possible reasons for this?

1. many of the products researched are supermarket products, facing transaction costs
2. retail business is still very much segmented nationally, in most countries a few supermarkets dominate

How might the theory of the firm invalidate the reasoning that eliminating exchange rate uncertainty increases welfare?

When the exchange rate fluctuates, profit of the firm depends on the price, which is p in the export market * the exchange rate. On average, the profit in the uncertainty case might be higher. The positive effect of price uncertainty on average profits must be compared to greater uncertainty.

Explain what tail risks are and how they motivated EU leaders to move into an MU

Exchange rate changes are large during turbulent periods and create tail risks: the risk of a very large change that occurs with low probability. But when it occurs: a devastating effect. The decline in the exchange rate can be so large that the price falls below MC, forcing the firm to shut down.

Quick depreciation of Italian lira in 1990. EU leaders wanted in MU because:
- it is difficult to manage exchange rates properly in a world of free capital mobility
- exchange rate movements were viewed as causes of asymmetric disturbances

Explain the difference between exogenous and endogenous growth models

In exogenous growth models, growth occurs if the population grows or if there is a technological change. In the short run, a lower r causes capital accumulation, stimulating growth, growth rate increases. In the long run, there is a higher output level, but a constant growth rate.

In endogenous growth models, capital accumulation increases productivity. A lower r causes capital accumulation, capital stock productivity increases, growth is stimulated. Both in the short and long run the growth rate increases.

Describe three benefits of a common currency

1. when a currency is used internationally, the issuer obtains additional revenues (small)
2. the currency is also held as international reserve by foreign central banks, foreign holders face the exchange risk > easier finance can lead governments to make excessive use of it, e.g. the US running unsustainable consumption booms
3. the currency boosts activity for domestic financial markets, attracting investors.
> UK also has booming financial activities, without euro

Why does the decline in exchange risk not necessarily reduce systemic risk?

Governments lose the capacity to guarantee that the outstanding stock of government bonds will always be repaid, which can unsettle the financial markets (liquidity crisis)

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The question on the page originate from the summary of the following study material:

Economics of Monetary Union | 9780199684441 | Paul De Grauwe

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The benefits of a common currency

10 important questions on The benefits of a common currency

Via which two ways does a common currency entail gains in economic efficiency?

What is the aim of SEPA?

Describe the TARGET system

How does a common currency benefit consumers?

Wolszczak-Derlacz (2006) find that price convergence happened before 1999, since the EU it has stopped. Studies show that the euro did not reduce price dispersion. What are possible reasons for this?

How might the theory of the firm invalidate the reasoning that eliminating exchange rate uncertainty increases welfare?

Explain what tail risks are and how they motivated EU leaders to move into an MU

Explain the difference between exogenous and endogenous growth models

Describe three benefits of a common currency

Why does the decline in exchange risk not necessarily reduce systemic risk?

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