Chapter 38

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Chapter 38

True/False
Indicate whether the statement is true or false.

The single European currency – the euro – came into existence on 1 January 2002.

In the context of the Single European Market project, the single European Currency was seen as a final step towards completing the single market.

Because international capital flows are so huge, currency pegs such as the Exchange Rate Mechanism are always vulnerable to speculative attacks.

The people who would lose their jobs working on currency transactions if the UK to join the European EMU represent a significant cost of adopting the euro.

The major cost to the UK of joining the euro would be the loss of the freedom for the country to set its own monetary policy and the loss of the possibility of needed adjustments in the UK economy being achieved through changes in the foreign exchange value of the UK currency.

In 2004 Germany had a lower degree of trade integration with the other EU countries than did the UK

Since the European EMU was established the degree of capital market integration among EMU member countries has increased substantially at both the level of the wholesale financial markets and the level of the retail financial markets.

The free rider problem that arises in a currency union is that a member government that borrows heavily may not be obliged to pay as high a rate of interest on its borrowing as it would if it were not a member of the currency union, while the other governments of the currency union find the financial markets require them to pay higher interest on their borrowing because of the high borrowing of one of their neighbours.

Eurozone countries in breach of the excessive deficit criterion could be subject to a fine of up to 1% of their GDP under the Stability and Growth Pact.

10.

Some of the criteria for deciding whether a group of economies constitute an optimum currency area are probably endogenous.

Multiple Choice
Identify the choice that best completes the statement or answers the question.

11.

Before Economic and Monetary Union (EMU) most EU member countries participated in something called the

a.	European Common Currency Area.
b.	Exchange Rate Model.
c.	European Monetary Union.
d.	Exchange Rate Mechanism.
e.	European Union Mechanism.

12.

Which of the following was not a goal of the EU in passing the 1986 Single European Act to complete the Single European Market (SEM)?

a.	The approximation of relevant laws, regulations and administrative provisions between member states.
b.	A common, EU-wide competition policy, administered by the European Commission.
c.	A common, EU-wide agricultural policy.
d.	The free movement of goods, services, labour and capital between EU member states.
e.	A system of common external tariffs implemented against countries that are not members of the EU.

13.

Which one of the following is rightly considered a cost of a single currency?

a.	The loss of the freedom for countries joining the single currency to set their own fiscal policies.
b.	The loss of the freedom for countries joining the single currency to set their own monetary policies.
c.	Higher unemployment.
d.	The loss of jobs involved in currency transactions.
e.	Higher inflation.

14.

Which one of these benefits of a single currency is not correctly explained?

a.	Using a single currency reduces price discrimination because companies will be obliged by law to charge the same prices for their goods in the different countries of the currency union.
b.	None of the benefits of a single currency described in these answers is incorrectly explained.
c.	Using a single currency reduces transaction costs involved in trade between members of a common currency area and the resources that are no longer employed in working on currency transactions can be used more productively to produce other goods and services.
d.	Using a single currency eliminates exchange rate variability for companies trading with other members of the common currency area and so companies may engage in more of this trade, and they can also eliminate the cost of entering into forward foreign exchange contracts with banks.

15.

If two countries, A and B, have separate currencies and there is a shift in consumer preferences away from the goods of country A and towards those of country B, then

a.	there will be an increase in inflation in country A.
b.	the foreign exchange value of country A’s currency is likely to rise, thus making country A’s goods relatively more expensive and worsening the reduction in aggregate demand in country A.
c.	the foreign exchange value of country A’s currency is likely to fall, thus making country A’s goods relatively cheaper and offsetting the reduction in aggregate demand in country A.
d.	there will be a fall in aggregate demand in country B.

16.

If two countries, A and B, are members of a currency union and there is a shift in consumer preferences away from the goods of country A and towards those of country B, then which one of the following would help to offset the effect of the resulting changes in aggregate demand in A and B on inflation and unemployment in the two countries?

a.	A high degree of labour mobility between the two countries.
b.	An increase in government spending in country A.
c.	A depreciation in the foreign exchange value of the common currency.
d.	A low degree of capital mobility between the two countries.
e.	A cut in taxes in both countries.

17.

Which of the following could not be described as an asymmetric macroeconomic shock?

a.	None of these answers. All of them are asymmetric macroeconomic shocks.
b.	A sudden and substantial fall in the worldwide demand for French wine.
c.	An epidemic of an animal disease in a country that significantly reduces the country’s agricultural output.
d.	A hurricane that disrupts economic activity in the USA.
e.	A sudden and substantial rise in prices on the world oil market.

18.

A high degree of real wage flexibility will tend to reduce the costs to a country of joining a currency union because

a.	all of the reasons given in these answers are correct.
b.	real wages fall rapidly in a recession and the economy moves quickly back to long-run equilibrium, so limiting the duration of the recession even when exchange rate adjustment is not possible.
c.	workers will move from a country in which aggregate demand falls to other countries of the currency union, and so unemployment remains lower than it otherwise would.
d.	real wages fall and so offset the inflationary effect of switching from the old currency to the new common currency.

19.

Which one of the following is not a characteristic that reduces the cost of a single currency?

a.	A high degree of labour mobility among the countries of the common currency area.
b.	A high degree of capital mobility among the countries of the common currency area.
c.	None of the characteristics described in these answers – they are all characteristics that reduce the cost of a single currency.
d.	Synchronized economic cycles in the countries of the common currency area.
e.	A high degree of trade integration among the countries of the common currency area.

20.

How does the eurozone compare with the USA as a possible optimal currency area (OCA)?

a.	The eurozone has a higher degree of labour mobility than the USA and labour law is much less restrictive in the eurozone than in the USA. On these measures, the eurozone is more likely to be an OCA than is the USA.
b.	The eurozone has a lower degree of labour mobility than the USA and labour law is much more restrictive in the eurozone than in the USA. On these measures, the eurozone is less likely to be an OCA than is the USA.
c.	The eurozone has a higher degree of labour mobility than the USA but labour law is much more restrictive in the eurozone than in the USA. On these measures, it is hard to judge whether the eurozone is more or less likely to be an OCA than is the USA.
d.	The eurozone has a lower degree of labour mobility than the USA but labour law is much less restrictive in the eurozone than in the USA. On these measures, it is hard to judge whether the eurozone is more or less likely to be an OCA than is the USA.

21.

What is fiscal federalism?

a.	A fiscal system for a group of countries in which fiscal policy is set in a treaty signed by all the countries.
b.	A fiscal system for a group of countries in which government budget deficits are strictly limited.
c.	A fiscal system for a group of countries involving a common fiscal budget and a system of taxes and fiscal transfers across countries.
d.	A fiscal system in which fiscal policy is jointly determined by local and national politicians.
e.	A fiscal system for a group of countries in which fiscal policy is set by the central bank.

22.

Which of the following is a problem for fiscal policy in a currency union?

a.	The central bank controls interest rates on long-term bonds issued by the governments of the member countries of the currency union.
b.	Governments of the member countries of the currency union may run large budget deficits and so crowd out private investment.
c.	Governments of the member countries of the currency union may run large budget deficits and so impose costs on other countries by pushing up interest rates on the bonds these countries’ governments issue.
d.	It is difficult to raise enough tax revenue to pay for the operation of the currency union.
e.	Governments of the member countries of the currency union may run large budget deficits and so force taxes to be increased across all countries of the currency union.

23.

To try to overcome the free rider problem, the members of EMU signed the

a.	stability and growth pact.
b.	European solidarity pact.
c.	exchange rate mechanism pact.
d.	responsibility and growth pact.
e.	fiscal stability pact.

24.

Which of the following is a problem for monetary policy in a currency union?

a.	Money supply is more difficult to control in a currency union.
b.	The inflation-unemployment trade-off is more unstable in a currency union.
c.	All of these answers describe problems for monetary policy in a currency union.
d.	The interest rate may be higher than is appropriate for economic conditions in some countries while it’s lower than is appropriate in some others – monetary policy must be “one size fits all”.
e.	Monetary policy will affect the economy with a longer time lag in a large currency union than in a single country.

25.

Which one of the following is not an argument in support of the UK joining the EMU?

a.	None of these arguments – they are all arguments in support of the UK joining the EMU.
b.	The characteristics of the UK housing market make UK consumers’ expenditure very sensitive to changes in interest rates.
c.	The UK risks exclusion from the Euroland capital market with damaging consequences for the City of London.
d.	The UK needs to be a member of the EMU in order to continue to attract such a large share of foreign direct investment in EU countries.
e.	The UK would benefit from increased trade with the eurozone countries, boosting GDP.