Riassunto International Economics, European Values in The Global Economy

MONETARY UNION

Asymmetric shocks adjustments: When countries join a monetary union they lose their monetary independence. This fact affects their capacity to deal with asymmetric shocks. When asymmetric shocks occur monetary union may be more costly and at the same time it can be very feable since the countries cannot use the exchange rates and interest rates.

There are two automatic adjustment mechanisms in case of permanent asymmetric shocks: wage flexibility and labor mobility. In the first one the adjustment takes place through prices instead in the second the adjustment takes place through the quantities. Assume two countries, France and Germany and we suppose that consumers shift their preferences way from French-made to German-made products. This fact implies a decline in aggregate demand in France and an increase in aggregate demand in Germany. If countries are part of a monetary union, the common central bank is paralyzed because it cannot use the exchange rates and the interest rates to

Germany. In this case, wage flexibility and labor mobility can help to alleviate the impact of the shocks. In France, with a recession and a decline in aggregate demand, flexible wages allow workers to reduce their wage claims. This helps to lower production costs and make French products more competitive in the international market. As a result, demand for French products increases, stimulating economic growth. On the other hand, in Germany, with a boom and an increase in aggregate demand, the excess demand for labor pushes up the wage rate. This attracts workers from France, where there is an excess supply of labor. The influx of French workers helps to meet the increased demand for labor in Germany, preventing labor shortages and supporting economic expansion. Overall, wage flexibility and labor mobility can help to restore equilibrium in both countries and mitigate the negative effects of asymmetric shocks. However, it is important to note that these measures may not be effective in cases of long-term structural imbalances or when shocks are not temporary.

Germany. There are two possible scenarios: the first one is that after some time in France will experience a boom and Germany a recession (if investors keep their trust toward the French government). The second one is that the recession is deeper in France (if investors lose their trust). We conclude that in a monetary union there is little scope for stabilization policies at the national level.

At the same time, there are other ways that can alleviate these problems. The budgetary union consists in centralizing a significant part of the national budgets into a common union budget. In this way, it achieves two things. First, it creates an insurance mechanism with income transfers from the country living good times to those hit by bad luck. Second, a budgetary union allows consolidating a significant part of national government debts and deficits, thereby protecting its members from liquidity crises and forced defaults.

The private insurance systems consist in the integration of capital markets,

which allow for automatic insurance against shocks.

The monetary union together with a budgetary union has a double effect. When if you introduce budgetary union or complete a monetary union, therefore the political union becomes more intense the oca line shifts to the left and the eurozone shifts to the right, because there is more symmetry. The probability of having asymmetric shocks, when there is a complete monetary union, is reduced. More flexibility, more symmetry in the shocks will have to make eurozone moves to the right, more redistribution and less fragility pushes the oca line to the left. Therefore the result is a complete monetary union that is more sustainable.

The Barro–Gordon model shows how the ability of government to manipulate leads to inflationary bias. Starting from the trade off between unemployment and inflation described by the Phillips curve. If there are two countries we add the purchasing power parity condition to link the inflation rates of two countries. These

Countries can adopt two strategies: the first Hard-nosed government and the second Wet government. Hard-nosed government attaches a lot of weight to fighting inflation, instead Wet government attaches a lot of weight to fighting unemployment. Hard-nosed government achieves lower inflation than wet government without imposing more unemployment in the long run.

In a monetary union there isn't a single optimal monetary policy for all countries, so this approach cannot be used. For example, we consider two countries: Italy and Germany. In Italy, the government attaches a lot of weight to fighting unemployment, in Germany the government attaches a lot of weight to fighting inflation. But to reduce unemployment, Italy will bear an increase of inflation. Only by abolishing the Italian central bank and adopting the mark, Italy can escape from high inflation equilibrium. Monetary union is more complicated because in a monetary union both countries must agree on a common monetary policy.

central banks decide jointly and a new currency is created. This leads to a problem because the new central bank may not have the same reputation as the German Bundesbank. The latter is reluctant to join. The Balassa-Samuelson effect identifies productivity differences, like the factor that leads to systematic deviations in prices and wages between countries, and between national incomes expressed using exchange rates and purchasing power parity (PPP). This effect occurs due to productivity growth differentials between the tradable and non-tradable sectors in different countries. High-income countries are more technologically advanced, and thus more productive, than low-income countries, and the advantage of high-income countries is greater for tradable goods than for non-tradable goods. According to the law of one price, the prices of tradable goods should be equal across countries, but not for non-tradable goods. Higher productivity in tradable goods will mean higher real wages for workers in.

that sector, which will lead to higher relative price(and wages) in local non-tradable goods that those workers purchase. Therefore, the long-run productivity difference between high- and low-income countries leads to trend deviations between exchange rates and PPP. This also means that countries with lower per capita income will have lower domestic prices for services and lower price levels. In the end the balassa-samuelson effect suggests that in developed countries, where productivity is already high and not rising as quickly, inflation rates should be lower; instead in developing economies should be more higher.

(bigliettino) Financial stability: Since the financial crisis of 2007-08 there is a new question: Is financial stability (FS) not equally, if not more important as an objective of the central bank? Before the crisis, the standard response was: first, by keeping prices stable the CB did all it could do to maintain FS. second, the main responsibility for maintaining FS is in the hands

of the main instruments that the ECB can use are: 1. Interest rates: The ECB can adjust the interest rates to influence the cost of borrowing for banks and individuals. By increasing interest rates, the ECB can discourage excessive credit growth and asset price increases. 2. Macroprudential measures: These are regulations and policies aimed at promoting financial stability. The ECB can implement measures such as loan-to-value ratios, capital requirements, and stress tests to ensure that banks have sufficient buffers to withstand potential shocks. 3. Communication and guidance: The ECB can use its communication channels to provide guidance and signals to the market about its intentions and expectations. This can help shape market behavior and prevent excessive credit growth and asset price bubbles. By using these instruments, the ECB aims to maintain both price stability and financial stability, ensuring a balanced and sustainable economic environment.

types of instruments: open market operations, standing facilities (credit lines), minimum reserve.

ECB in January 2015 to finally start expanding the money base by buying large amounts of government bonds in the hope of pushing inflation up again. But this intervention led to the expansion of the balance sheet of eurosystem.

2nd generation model: In the second generation model we assume country on fixed exchange rate experiences a current account shock: a sudden increase in current account deficit. This leads to an increase in foreign debt. If the current account deficit is not corrected, foreign debt becomes unsustainable and the country will default. The country can solve this problem in two ways: through expenditure reducing policies and devaluing the currency. We suppose that the first policy is more costly than the second policy.

BE curve represents benefits of devaluation when devaluation is expected, BU curve represents benefits of devaluation when devaluation is not expected. The BE curve is

located above the BU curve because when evaluation is expected (when there is a speculation attack) the cb will have to raise the interest rate to defend the fixed exchange rate regime. The need to raise the i is absent when the devaluation is not expected. Therefore the defence of a fixed exchange rate will be more costly when devaluation is expected than when is not expected. There are three shock: a small shock e<e1 where there will be no devaluation because cost exceeds the benefits, therefore the fixed exchange rate is credible thus the current account deficit can easily be financed; a large shock (e>e2) where there will be always devaluation because the benefits exceed the cost; the fixed exchange rate is not credible thus the devaluation occurs. An intermediate shock e1<e<e2 where there are two possible equilibria (N and D), thus the devaluation depends on speculators’ expectations. In N speculators don’t expect a devaluation, cost>benefits, the devaluation

don’t occurs; in D speculatorsexpect a devaluation, benefits>cost, the devaluation occurs. Expectations are self-fulfilling.

The reason who there are two possible equilibria depens on the fact the central bank has a limited international stock of reserves. suppose that the central bank had an unlimited international stock of reservesso when a speculative attack occurs the central bank would always be able to counter the speculators byselling an unlimited amount of foreign exchange. The be curve would coincide with the bu curve.

In general we can conclude that the limited stock of international reserves reduces the credibility and lowcredibility leads speculators to sell the domestic currency, forcing the central bank to sell foreign exchange,thereby reducing the amount of international reserves.

Debt/GDP condition: The Maastricht Treaty was signed in 1991. It is based on two principles: Gradualism:the transition towards monetary union in Europe is seen as a gradual one.

Convergence criteria: entry into the union is made conditional on satisfying convergence criteria. Convergence criteria for each candidate country:

1. (1) inflation rate average of three lowest inflation rates in the group of candidate