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Macroeconomic Analysis course
Nova School of Business and Economics
3 December 2012
Ariane Dinis (532)
Isabel Felino (274)
Marta Costa (531)
“ What are the challenges posed by
OCA theory on the European EMU?”
Agenda and Motivation
Francesco Mongelli (ECB)
research from 2002 to 2006
Optimal Currency Areas
- Definition and Evolution
- Endogeneity paradigms
European Monetary Union
- Overview and Prospects
• OCA Theory and properties 60s – 70s
Pioneering phase
• Inconclusiveness of diverse proprieties combined
• CBA vs OCA properties
70s
Reconciliation phase
• Reinterpretation of proprieties
• Reassessment of benefits and costs
• The balance in favor of EMU
80s-90s
Reassessment phase
• Theory subject to empirical analysis
80s-present
Emprirical phase
Theory of Optimal Currency Areas
OCA properties
OCA properties
Price and wage flexibility,
Mobility of labor and other factors of production,
Financial market integration,
Economic openness,
Diversification in production and consumption,
Similarity in inflation rates,
Fiscal integration and political integration.
Optimum currency area (OCA): optimal geographical area for a
single currency, or for several currencies, whose exchange rates are
irrevocably pegged. The single currency, or the pegged currencies,
fluctuate jointly vis-à-vis other currencies.
Why is the OCA theory relevant for
the EMU?
The implication for the European Economic and Monetary Union
(EMU) is that Euro Area may, overtime, turn into a Optimal
Currency Area (OCA ) after the Monetary Union
Endogeneity of OCA Flexibility
(Monetary Integration)
Income Correlation
(Symmetry)
Integration
(Openness to Trade)
Sources
Endogeneity of Financial Integration
Endogeneity of Symmetry of shocks
Endogeneity of Labor and Product Markets
Flexibility
(Monetary Integration)
Income Correlation
(Symmetry)
Integration
(Openness to Trade)
Endogeneities: Market-based
Endogeneity of Symmetry of shocks
Financial Integration
Risk Sharing Business cycle Synchronize
Less national Specialization
Symmetric shocks
Flexibility
(Monetary Integration)
Income Correlation
(Symmetry)
Integration
(Openness to Trade)
Endogeneities: Market-based
Endogeneity of Financial Integration
Financial instruments
Allocation Capital (FDI)
Equity Income
insurance
Exogeneity of OCA
Institutional integration
Economic integration
Structural Rigidities:
-labour market institutions
- Product market regulations
- Financial market integration
OCA theory: “OCA theory in reverse” – distinguish countries underperform under some OCA properties
Endogeneity of Labor and Product:
- Estabilished indicators and reforms (flexibilize and uniformize) OECD Job Strategy,
- Lisbon Agenda Four areas : 1. Improving knowledge and innovation; 2. Making the EU an attractive area to invest and work; 3. Fostering growth and employment (social cohesion); 4. Promoting sustainable development and human capital.
Exogeneity of OCA
Institutional integration
Economic integration
• Inflation dispersion among euro area is stabilised at extremely low historical levels
• Euro area inflation differentials are quite persistent over long periods
Inflation
Interest Rates
• Real long-term interest rates are now quite low and stabilised
• Persistent real interest rate differentials depend mainly on the persistent of inflation
Real Exchange Rate
• Divergences in price and cost competitiveness can still occur
• Appreciations of REER has led to losses in export shares
From the data to OCA to EMU Base Convergence on the OCA Theory:
- Significant financial Integration is necessary (but only concern?)
The EMU still has structural weakeness:
- Doesn’t take into account political forces
The OCA theory explain effects until 2006.
Financial crisis enhanced the weakeness of a large dependency financial
system
Endogenous responses: strong enough to improve the adjustment process
and reduce disturbances
- Drawback: exogenous institutional framework to improve market
flexibility is necessary.
Expectations?
Conclusion
The current crisis has been the most critical stage for the Euro area. The ECB have been effective and powerful to maintain price stability. But, exiting of the crisis will depend on the success of the economic and
institutional reforms.
Currently: reforms towards calming tensions in sovereign debt markets: credibility of financial institutions and governments.
Coming years debate on: economic and political frameworks, risks emanating from global imbalances, need for further international coordination and cooperation.
The various reform processes must be given the time and confidence needed to display they effects.
Discussion
• What do you think is going to be the future of the Euro?
• Is the OCA the main framework to be analyzed when a country
decides to enter or not in the Currency Union?
• Will be converge to a Optimal Currency Area as described above?