Essential Question

Should Europe abandon the Euro?

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Downward Sloping Demand Curve

As the Pound depreciates, Americans import more British goods. To pay for those goods, Americans buy pounds.

Upward Sloping Supply Curve

As the Pound appreciates, the British import more American goods. To pay for those goods, the British buy dollars with pounds, increasing the quantity supplied of pounds.

Determinants of Exchange Rates

Changes in Tastes

Relative Income Changes

Relative Price Level Changes

Relative Interest Rates

Speculation

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IntroductionFigure 20-1: Members of the Euro Zone as of January 1, 2001

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• The euro: A European Union in which national currencies are replaced by a single EU currency managed by a sole central bank that operates on behalf of all EU members.

What is the Euro?

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–Greater degree of European market integration

–Complete freedom of capital movements

–Political stability of Europe

Why a single currency?

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What Is an Optimum Currency Area?

• It is a region where it is best (optimal) to have a single currency.

• Optimality depends on degree of economic integration:

– Trade in goods and services

– Factor mobility

• A fixed exchange rate area will best serve the economic interests of each of its members if the degree of output and factor trade among them is high.

The Theory of Optimum Currency Areas

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The Theory of Optimum Currency Areas

Monetary efficiency gain: Countries benefit by avoiding the uncertainty, confusion, and calculation and transaction costs that arise when exchange rates float.

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But….

• Economic stability loss: Countries are hurt, as they give up their ability to use the exchange rate and monetary policy for the purpose of stabilizing output and employment.

Greece, Ireland and Portugal are examples of countries in Europe that would benefit right now from an independent monetary policy. These are countries in recession that would benefit from an expansionary monetary policy. However, they are forced to accept the ECB’s policy for the entire Euro zone.

The Theory of Optimum Currency Areas

Does economic integration foster economic growth and development?

Definitions

Globalization: The idea that national economies around the world are growing increasingly interdependent and that the world economy is increasing interconnected.

Industrialized Countries: High income countries that have highly developed market economies and large stocks of technologically advanced capital goods and skilled labor forces.

Developing Countries: Low income countries that are characterized by lack of capital goods, low stocks of technologically advanced capital goods and unskilled labor forces.

Growth versus Development

Economic growth

• A measure of the value of output of goods and services within a time period

Economic Development

• A measure of the welfare of humans in a society