Lecture 6
Economic Monetary Union
Optimal Currency Area Theory
Costs & Benefits of EMU
Ancient Rome
Stephen Kinsella
www.stephen kinsella.net

Background

1990––1999
1. Free Movement of Capital
Coordination of Ec. Policy
2.
Independent Central Banks
The Euro
3. Common Monetary Policy
The ECB

Benefits of a Single
Currency

Inflation Convergence Within Six Original EMS Members,
1978-2000

So ....
Less transactions costs
More price transparency
Less uncertainty
More economic growth

Less transactions costs
Elimination of foreign exchange markets
within union eliminates cost of
exchanging one currency into another
Cost reductions amount to 0.25 to 0.5%
of GDP

Price transparency
One common unit of
account facilitates price
comparisons
Consumers “shop
around” more
Competition increases
Prices decline and
consumers gain

Will euro increase price transparency in a significant
way?
Large price differentials continue to exist
These have to do with
transactions costs at the retail level
and product differentiation

Handout

Less Uncertainty

Does the decline in
exchange risk increase
welfare?

Price Certainty Price Uncertainty
P P
MC MC
X
P3
P1 P1
A
P2 A
Y
Q Q
Profit = A-(Area of ) Profit = A-(Area of )+X+Y

Profits are higher on average
when there is price certainty
Welfare will then depend on
degree of risk aversion
If risk aversion sufficiently high
price certainty is preferred by
firms

More economic growth

Empirical evidence
about monetary
union and growth

Next Week
Benefits & Costs of a Single Currency
We’ll develop Optimal Currency Area Theory
Read
Pelkmans, J. European Integration: Methods and
Economic Analysis 1st ed., pgs. 83–104 and 133–
155. 337.142 PEL.