optimal currency area theory the case of sweden and the emu ithurbide: prévision des taux déchange...
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Optimal Currency Area TheoryOptimal Currency Area TheoryThe Case of Sweden and the EMUThe Case of Sweden and the EMU
Ithurbide: Prévision des taux d’échangeIthurbide: Prévision des taux d’échange
Györgyi Kacsandi, Signe Svensson, Stefan Zeugner, 2002Györgyi Kacsandi, Signe Svensson, Stefan Zeugner, 2002
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
Overview
€ Question€ Theory
€ What is an asymmetric shock?€ OCA Criteria
€ Case Application: Sweden€ Statistic Study€ Conclusion€ Academic Results
DISPOSITIONDISPOSITION
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
Is the EMU an Optimum Currency Area for Sweden?
QUESTIONQUESTION
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
Time line€ 1995 Sweden joins the EU€ 1996 The Swedish Government launches «Wait
and See» Policy considering EMU€ 1999/2002 The EMU is put into reality by the
introduction of the Euro in the 12 memberstates
€ 2002 Swedish prime minister says that thesmooth introduction of the euro advancesthe date of a possible referendum to notlater than 2005, and most likely 2003.
QUESTIONQUESTION
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
Why Sweden adopted « Wait and See » policy in 1996:
• Financial Situation of the State
• The Rate of Unemployment
• Not Sufficient Debate; Legitimacy
• Other EU-countries
QUESTIONQUESTION
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
Definition
An Optimum Currency Area is an area
neither so small and open that it would be better off pegging its currency to a neighbor,
nor so large that it would be better off splitting into sub-regions with different currencies.
THEORYTHEORY
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
What is an asymmetricshock?
THEORYTHEORY
Airbus Supply
Camembert Supply
Airbus Demand
q
p
q
p
Camembert Demand
PA
PC
Excess supply for Airbus
Excess demand for Camembert
Assumptions:• Price levels stick to their initial level• Initial current account is balancedAsymmetric shock:• Productivity increase in Airbus
production
THEORYTHEORY
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
France is devided into two currency areas: in the Northeast the NE-Franc and in the Southwest the SW-Franc:
In the booming Northeast, interest rates rise – whereas in the staggering Southeast they fall. The NE-Franc appreciates versus the SW-Franc and the justified prices are quickly reached on « international » markets.
But there is no inflation in the NE and no monetary-caused unemployment in the SW.
Moreover, each region can fine-tune its monetary policy to its particular shock.
I. Flexible Exchange Rates
THEORYTHEORY
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
In order to decrease the excess supply of Airbuses, workers will « quit » their jobs in the Southwes, move to the Northeast and will become Camembert producers. Camembert supply will increase (shift to the right), Airbus supply will decrease (shift to the left) The price movements are by far not as excessive as in case I.
II. Fixed Exchange Rates:Labor mobility
THEORYTHEORY
Airbus Supply
Camembert Supply
Airbus Demand
q
p
q
p
Camembert Demand
PA
PC
THEORYTHEORY
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
III. Fixed Exchange Rates:Adjustment of Prices
Labor productivity has increased one needs less work hours to build an Airbus (relative to work hours for making Camembert) The price of an Airbus in terms of Camemberts falls the producers (workers) of Airbuses receive less Camemberts in total (real wage)i.e. incomes in the Southwest deteriorate, while the Northeast is experiencing a boom. This implies falling wages (along with the prices) in the Southwest – or unemployment. The Northeast will suffer from inflation.
THEORYTHEORY
PC
PC
Camembert Demand
PA
PA
Airbus Supply
Camembert Supply
Airbus Demand
q
p
q
p
THEORYTHEORY
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
Why should France have a common currency?Decision rule: Common currency if the advantages > disadvantages in the long run
Advantages• Reduce transaction
costs and exchange rate risk
• Provide a nominal anchor for nominal policy
Disadvantages• No independent
monetary policy
i.e. if France forms an Optimal Currency Area!
THEORYTHEORY
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
Fixed Exchange Rates – Common Currency
Reducing the risk of assymetric shocks:
Symmetric disturbances business cycle correlation
High trade integration leads to higher income correlation
Product diversification in the region
Dampening the effects of assymetric shocks:
Labor mobility
Price flexibilty wage flexibilty
High trade integration (because of the marginal propensity to consume)
Fiscal federalism
THEORYTHEORY
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
The Case of EMU and SwedenLabor mobility:
Currently 1.9% of labor force in EU countries comes from another EU member state. In the U.S., 1,5% of population are moving inter-state every year!
Fiscal Federalism:
If a U.S. state suffers an income shock, it will be compensated for 40% of the loss by fiscal federalism (less taxes, more subsidies).The EU budget is limited to 1.27% of EU-GDP.
CASE APPLICATIONCASE APPLICATION
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
Fixed Exchange Rates – Common Currency
Reducing the risk of assymetric shocks:
Symmetric disturbances -> business cycle correlation
High trade integration leads to higher income correlation
Sectoral diversification in the region
Dampening the effects of assymetric shocks:
Labor mobility
Price flexibilty -> wage flexibilty
High trade integration (because of the marginal propensity to consume)
Fiscal federalism
CASE APPLICATIONCASE APPLICATION
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
Four main criteria for OCA of Sweden and EMU
Sectoral diversification
Correlation of income cycles
High trade integration
Similarity in price and wage patterns
CASE APPLICATIONCASE APPLICATION
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
SEK to Foreign Currencies
0
2
4
6
8
10
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
t
SE
K /
curr
ency
uni
t
USD DEM FRF
Statistic results
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
Statistic results
Source: OECD STAN.
Differences in Production
1970 1993
US 0,85 US 0,86Great-Britain 0,83 Finland 0,85France 0,81 Germany 0,83Germany 0,81 Great-Britain 0,78Denmark 0,77 France 0,78Finland 0,76 Denmark 0,71
Average 0,78 Average 0,79
CASE APPLICATIONCASE APPLICATION
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
Statistic results
Correlation in GDP growth (to Sweden)
-0,5
0
0,5
1
Denm
ark
Finlan
d
Franc
e
Germ
any
Great
-Brit
ain
USA
1965–94
1965–79
1980–94
Source: OECD National Accounts.
CASE APPLICATIONCASE APPLICATION
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
Statistic results
Correlation - Asymmetric shocks to Sweden 1963-1990
-0,20
0,20,40,6
Supply Shocks
Demand Shocks
Source: OECD National Accounts.
CASE APPLICATIONCASE APPLICATION
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU CASE APPLICATIONCASE APPLICATION
Percentage of Sweden's Trade with:
0,00%
5,00%
10,00%
15,00%
20,00%
25,00%
30,00%
35,00%
40,00%
45,00%
EMU D FIN USA UK F
Statistic results
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
Statistic results
Index of "Optimal" Member Countries in a Swedish Currency Union
0
2
4
6
8
10
Ind
ex
(1
-10
)
Finland
Denmark
Germany
France
Great Britain
US
Source: Jonung och Sjöholm [1997b].
CASE APPLICATIONCASE APPLICATION
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
Our conclusion€ The criteria are not sufficiently fulfilled to
make the EMU an Optimum Currency Area for Sweden
€ However, the development shows that the EMU might be so in the future
€ If Sweden chooses to join for political reasons,
Sweden might suffer asymmetric shocks due to the little correlation to the other EMU countries Sweden should try to achieve increased price and wage flexibility to damp the socio-economic costs of OCA
CONCLUSIONCONCLUSION
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
Academic results (Rose, 2001)
€ AssumptionsTrade patterns and income correlations are endogenous – what happens in the long run?
€ How?Econometric research on trade streams
€ Result?Participating in a common currency area has a large positive impact on trade, which can be quantified.
ACADEMIC RESULTSACADEMIC RESULTS
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Optimum Currency Area Theory Optimum Currency Area Theory The Case of Sweden and the EMUThe Case of Sweden and the EMU
(Rose, 2001) cont.
€ Prognosis?€ If Sweden joins the EMU for
political reasons, it will be more likely to fulfill the OCA Criterions in the future
€ Entering the EMU would also increase Swedish trade with the EU by 50-300% increase Swedish GDP by about 11 %
ACADEMIC RESULTSACADEMIC RESULTS
Statistic results