optimal currency area theory the case of sweden and the emu ithurbide: prévision des taux déchange...

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

33


Is the EMU an Optimum Currency Area for Sweden?

QUESTIONQUESTION

44


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

55


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

66


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

77


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

99


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

1010


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

1212


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

1414


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

1515


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

1616


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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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


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Four main criteria for OCA of Sweden and EMU

Sectoral diversification

Correlation of income cycles

High trade integration

Similarity in price and wage patterns


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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

2020


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


2121


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.


2222


Statistic results

Correlation - Asymmetric shocks to Sweden 1963-1990

-0,20

0,20,40,6

Supply Shocks

Demand Shocks

Source: OECD National Accounts.


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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

2424


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].


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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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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

2727


(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

optimal currency area theory the case of sweden and the emu ithurbide: prévision des taux déchange...

Documents

airbus production slide

labor mobility slide

fiscal federalism slide

airbus excess demand

airbus relative

camembert producers

sweden labor mobility

statistic results source