Essay 4
“Perhaps they will be lucky. It may be that events, as they turn out in the next 10 or 20 years, will be common to all the countries; there will be no shocks, no economic developments that affect the different parts of the Euro area asymmetrically. In that case, they’ll get along fine.
On the other hand, the more likely possibility is that there will be asymmetric shocks hitting the different countries. That will mean that the only adjustment mechanism they have to meet that with is fiscal and unemployment: pressure on wages, pressure on prices.” (Milton Friedman, 1998). Explain this statement and discuss it in the light of developments in the Eurozone since 2009.
Milton Friendman talks about the concerns of the EMU – a monetary union with one currency, the Euro, managed by a sole central bank, launching within the euro area in 1992 resulting in a fixed exchange rate between the members. The statement stresses that by adopting a single currency; the differences in the member countries will result in asymmetric shocks and further problems. This is associated with the theory of optimum currency areas which implies that countries wishing to join the fixed exchange rate area successfully is linked to high economic integration. This statement questions the extent of Eurozone being an OCA.
There are many reasons for adopting a common currency - having a fixed exchange rate means that a joining country gives up its ability to use a floating exchange rate and control of monetary policy (therefore unable to control interest rates) for the purpose of stabilising output and employment.
To explain further, I will first talk about the exchange rate framework. A countries exchange rate can be fixed or floating. The open market equilibrium condition is: y t = a t + δ ( s t + p t*- p t ) + g t
The FEM is in equilibrium when the interest parity condition holds (when expected rates of return on domestic and foreign currency deposits are equal): i t = i t* + E t s t + 1 - s
On the other hand, the more likely possibility is that there will be asymmetric shocks hitting the different countries. That will mean that the only adjustment mechanism they have to meet that with is fiscal and unemployment: pressure on wages, pressure on prices.” (Milton Friedman, 1998). Explain this statement and discuss it in the light of developments in the Eurozone since 2009.
Milton Friendman talks about the concerns of the EMU – a monetary union with one currency, the Euro, managed by a sole central bank, launching within the euro area in 1992 resulting in a fixed exchange rate between the members. The statement stresses that by adopting a single currency; the differences in the member countries will result in asymmetric shocks and further problems. This is associated with the theory of optimum currency areas which implies that countries wishing to join the fixed exchange rate area successfully is linked to high economic integration. This statement questions the extent of Eurozone being an OCA.
There are many reasons for adopting a common currency - having a fixed exchange rate means that a joining country gives up its ability to use a floating exchange rate and control of monetary policy (therefore unable to control interest rates) for the purpose of stabilising output and employment.
To explain further, I will first talk about the exchange rate framework. A countries exchange rate can be fixed or floating. The open market equilibrium condition is: y t = a t + δ ( s t + p t*- p t ) + g t
The FEM is in equilibrium when the interest parity condition holds (when expected rates of return on domestic and foreign currency deposits are equal): i t = i t* + E t s t + 1 - s