5. Central Bankers Bernard Bernanke Chairman of the Federal Reserve Mervyn King Governor of the Bank of England Jean-Claude Trichet President of the European Central Bank
15. Optimal Currency Zones Labour Market Flexibility Real Economic Convergence Highly Flexible Inflexible Divergent Convergent
16. Optimal Currency Zones Labour Market Flexibility Real Economic Convergence Highly Flexible Inflexible Divergent Convergent High risk currency union
17. Optimal Currency Zones Labour Market Flexibility Real Economic Convergence Highly Flexible Inflexible Divergent Convergent Monetary Union Works High risk currency union
18. Is the Euro an Optimal Currency Zone? Professor Robert Mundell The 1999 Nobel Prize Winner "for his analysis of monetary and fiscal policy under different exchange rate regimes and his analysis of optimum currency areas"
Arguments continue to rage as to whether the twelve countries within the Euro Zone stand to benefit from a ‘one-size fits all monetary policy’. Are they sufficiently similar (or convergent) in terms of economic performance for the benefits of Euro membership to outweigh the costs of having to accept a single rate of interest?
The ECB is in charge of setting a common interest rate for the twelve countries inside the Euro Zone. The main policy objective is to achieve price stability – defined as “a year-on-year increase in the Harmonised Index of Consumer Prices of below 2%”.
The ECB targets the growth of the broad money supply as a guide to the future direction of interest rates. Broad money is basically determined by the growth of bank deposits – the majority of which are created through bank loans and over-drafts. The ECB does not have an exchange rate target, although it has intervened on a few occasions to influence the external value of the Euro
Structural convergence analyses whether the supply-side structures of the British economy might be different to countries within the Euro Area. And, if they are, the extent to which different structures could make the UK more vulnerable to economic shocks that do not affect the rest of the euro area (for example, volatility in house prices). There is also the risk that the UK could react differently to changes in circumstances that affect the whole of the monetary union (e.g. changes in Euro Zone interest rates).
Structural convergence analyses whether the supply-side structures of the British economy might be different to countries within the Euro Area. And, if they are, the extent to which different structures could make the UK more vulnerable to economic shocks that do not affect the rest of the euro area (for example, volatility in house prices). There is also the risk that the UK could react differently to changes in circumstances that affect the whole of the monetary union (e.g. changes in Euro Zone interest rates).
he concept of an optimal currency area (OCA) is important to the debate about the Euro. An OCA works best when the countries within it are already highly integrated with each other and where each has a sufficiently flexible labour market to cope with external economic shocks . The OCA is also likely to work well when the monetary policy transmission mechanism works in similar ways within each country – in other words, the effects of interest rate changes have a broadly similar impact on businesses and households, and the time lags involved in interest rate changes working their way through to affect output, employment and prices are pretty close to each other.
In most important respects, the Euro Zone is not an OCA – although a small group of countries within it are probably closely convergent in a structural sense. An OCA is better placed to succeed with a small cluster of countries rather than the looser coalition of twelve nations that count themselves as founder members of the single currency.
Membership of the Euro should in practice make it easier for consumers and businesses to compare relative price s levels across member nations. This will encouraged increase cross-border trade and increase the competitive pressures across many different markets. There are potential gains in consumer welfare if price transparency leads to improvements in allocative efficiency .
The Euro is vital as a complement to the success of the Single European Market. This should lead to an increase in intra-European trade flows and higher inward investment within the EU region. Britain stands to gain from this, particularly if she can maintain low cost and price inflation and raise productivity of British firms operating in competitive European markets.
Critics of the Euro argue that the new currency does not meet the requirements of an optimal currency area and that structural economic differences between member nations threaten to undermine the success of the project. Other economists believe that the UK can continue to enjoy a sustained period of macroeconomic prosperity outside the Euro Zone whilst still deriving some of the benefits from participation in the single European market.
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