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ball_chapter_17_2nd_edition_s.pptxMoney, Banking, and Financial Markets
Chapter 17: Monetary Policy and Exchange Rates Power Point Slides by Jim Butkiewicz
CHAPTER 17 Monetary Policy and Exchange Rates
Learning Objectives
This chapter introduces you to issues involving:
Exchange rates and stabilization policy
The costs of exchange-rate volatility
Exchange-rate policies
Fixed exchange rates
Currency unions
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This chapter examines exchange-rate policy.
CHAPTER 17 Monetary Policy and Exchange Rates
Exchange Rates and Stabilization Policy
Monetary policy actions change exchange rates:
An increase in interest rates reduces net capital outflows and appreciates the currency.
This is part of the transmission of monetary policy.
Many non-monetary factors can change exchange rates:
A loss of confidence by asset holders or a shift in commodity prices will change exchange rates.
If such events destabilize the economy, a central bank will react attempting to restore stability.
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Shifts in monetary policy can be causes of exchange-rate movements or reactions to exchange-rate movements.
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Exchange Rates and Aggregate Expenditure
Assume that confidence in the country of Boversia improves, reducing net capital outflows (NCO) in terms of the local currency (the bover).
The NCO curve shifts left, appreciating the real exchange rate (ε) and reducing net exports (NX).
The fall in NX shifts the AE curve to the left.
If the real interest rate is held constant, the shift of AE causes a recession.
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A loss of confidence shifts NCO to the right, increasing NX, shifting AE to the right, and creating an economic boom and increased inflation.
Figure 17.1 Rising Confidence in Boversia
When Boversia’s assets become more attractive to foreign savers, its net capital outflows fall and its real exchange rate rises. The higher exchange rate reduces net exports (A), shifting the aggregate expenditure curve to the left (B). If the central bank holds the real interest rate constant, output falls.
Real exchange rate, ε
Bovers
(A)
NCO1
NCO2
NX
Real interest rate, r
Output, Y
(B)
AE1
AE2
Y*
Real interest rate chosen by central bank
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CHAPTER 17 Monetary Policy and Exchange Rates
Offsetting Exchange-Rate Shocks
To keep real output at potential after the improvement in confidence, the central bank lowers the real interest rate.
The lower real interest rate increases net capital outflows and depreciates the real exchange rate part of the way back to its original value, so net exports remain lower than their original value.
The lower real interest rate increases investment and consumption, offsetting the fall in net exports and keeping real output at potential.
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The central bank could lower rates further to keep net exports at their original value, but this is not necessary to maintain output stability.
Figure 17.2 Rising Confidence and Output Stabilization
As in Figure 17.1, higher confidence in Boversia shifts both the NCO curve and the AE curve to the left. But now the central bank reduces the real interest rate to keep output at potential (B). This action shifts the NCO curve to the right but does not fully offset the shift caused by higher confidence. The real exchange rate rises above its initial level (A).
ε
Bovers
(A)
NCO1
NCO2
NX
NCO3
Effect of r
Effect of higher confidence
r
Y
(B)
AE1
AE2
Y*
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Confidence and Stability
A decrease in confidence shifts NCO right, reducing the real exchange rate and shifting AE right, increasing output.
The change in output changes inflation along the Phillips curve.
Shifts in confidence and exchange rate changes destabilize output and inflation.
CHAPTER 17 Monetary Policy and Exchange Rates
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A decrease in confidence has the opposite effects of an increase.
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Rising Confidence in Boversia
The Phillips curve captures the positive short-run relationship between output and inflation.
π
Y
Phillips curve
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Figure 17.3 Effects on Components of Spending
When confidence in Boversia rises and the central bank stabilizes output, the exchange rate rises and the interest rate falls. These changes have offsetting effects on aggregate expenditure.
Overall, output is constant.
Real exchange rate (from in confidence of foreign savers; only partly offset by real interest rate)
Real interest rate by central bank
Net exports
Consumption
Investment
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CHAPTER 17 Monetary Policy and Exchange Rates
Offsetting Exchange-Rate Shocks
Due to time lags and uncertainty about policy effects, central banks dampen the effects of exchange-rate shifts, but exchange-rate shocks still result in some output instability.
In small countries exports are a large percentage of GDP, so central banks react strongly.
In the U.S. exports are about 15% of GDP, so the Fed focuses more on domestic factors and usually pays little attention to exchange rates.
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In some small countries exports can be half or more of GDP. This is comparable to states within the United States. For most states, trade with other states is a very large percentage of a state’s GSP (Gross State Product).
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Risk and Global Economic Integration
Exchange-rate risk discourages international trade and capital flows, favoring domestic markets and assets.
Reducing international trade reduces economic growth.
International trade promotes comparative advantage.
Competition from trade makes domestic producers more efficient.
Trade helps spread technologies.
Capital flows, an important source of finance in developing countries, are reduced by volatile exchange rates.
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Exchange-rate risk hurts the global economy.
Exchange Rate Policies
Central banks use several methods to control exchange rates.
Interest-rate adjustments
Foreign-exchange interventions
Capital controls
Policy coordination
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Each method of stabilizing exchange rates has drawbacks.
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CHAPTER 17 Monetary Policy and Exchange Rates
Exchange-Rate Policies and Their Pitfalls
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Insert table 17.1 here.
CHAPTER 17 Monetary Policy and Exchange Rates
Interest Rate Adjustments
Interest rate adjustments offset shocks to exchange rates.
Increased real interest rates increase the real exchange rate, and vice versa.
Interest rate adjustments to stabilize exchange rates can conflict with the rates needed to stabilize output and inflation.
The real interest rate adjustment needed to keep exchange rates constant after a shock to NCO results in a change in output.
A shock to AE that requires an interest rate change will change the exchange rate, which may be undesirable.
Policymakers look for alternative ways to stabilize exchange rates that don’t affect output or inflation.
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The goals of internal and external balance may conflict.
Figure 17.4 Stabilizing the Exchange Rate
Here, increased confidence shifts the NCO curve to the left, but the central bank lowers the interest rate enough to reverse the shifts completely. The real exchange rate doesn’t change (A). The lower interest rate pushes output above potential despite the inward shift of the AE curve (B).
ε
Bovers
(A)
NCO2
NX
NCO3 = NCO1
Effect of r
Effect of
higher confidence
Real exchange rate days constant
r
Y
(B)
AE1
AE2
Y*
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Figure 17.5 A Domestic Shock and Output Stabilization
Here, Boversia’s AE curve shifts due to a domestic shock. The central bank reduces the real interest rate to keep output constant (B). The lower interest rate shifts the NCO curve to the right, reducing the real exchange rate (A).
ε
Bovers
(A)
NCO 1
NX
NCO 2
Effect of r
Central bank reduces r to keep Y constant
r
Y
(B)
AE1
AE2
Y*
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CHAPTER 17 Monetary Policy and Exchange Rates
Foreign-Exchange Interventions
Foreign-exchange interventions are purchases and sales of foreign currencies by central banks.
Interventions requires international reserves, which are liquid assets held by central banks that are denominated in foreign currencies.
Reserves are typically held in bonds of the foreign government.
Trading domestic currency for a foreign currency increases international reserves, and vice versa.
When a central banks sells foreign currency, it first sells its foreign bonds to obtain the foreign currency.
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In 2007 the Fed owned about $70 billion of international reserves.
Figure 17.6 Foreign Exchange Interventions and International Reserves
Central bank trades its currency for foreign currency…
…uses foreign currency to buy foreign assets
International reserves increase
Central bank sells foreign assets for foreign currency…
…trades foreign currency for own currency
International reserves decrease
OR
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Effects of Interventions
Interventions affect exchange rates by changing the supply and demand for currencies.
If the Fed sells dollars for euros, the supply of dollars increases and the dollar depreciates.
If Boversia’s central bank uses domestic currency to buy foreign currency that it uses to buy foreign assets, NCO shifts to the right, reducing the real exchange rate, and vice versa.
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Interventions are an alternative way of stabilizing the exchange rate.
Figure 17.7 Interventions and the Exchange Rate
Purchases of foreign currency by the central bank raise net capital outflows and reduce the real exchange rate (A). Sales of foreign currency have the opposite effects (B).
ε
Bovers
(A) Central bank buys foreign currency
NCO 1
NCO 2
ε
Bovers
(B) Central bank sells foreign currency
NCO 1
NCO 2
NX
NX
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Why Interventions?
Exchange-rate stabilization using interest rates has the undesirable side effect of changing output and inflation.
Intervention stabilizes the exchange rate without changing interest rates.
If the exchange rate remains constant, net exports are constant and the AE curve doesn’t shift, so output and inflation remain constant.
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Intervention stabilizes the exchange rate without creating an inflationary boom.
Figure 17.8 Interventions and the Exchange Rate Stabilization
Here, increased confidence shifts the NCO curve to the left, but the central bank reverse the shift by purchasing foreign currency. The exchange rate does not change (A). The AE curve does not move and the central bank holds the interest rate constant, so output does not change (B).
ε
Bovers
(A)
NX
NCO3 = NCO 1
Effect of intervention
Effect of
higher confidence
NCO 2
r
Y
(B)
AE
Y*
Real exchange rate days constant
r chosen by central bank
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CHAPTER 17 Monetary Policy and Exchange Rates
Who Intervenes?
The Bank of Japan sold yen repeatedly in 2003 and 2004, attempting to hold down the yen’s value to stimulate exports and increase output.
Mexico and South Korea bought their own currencies in 2008-2009 in response to falling confidence in their economies.
The Fed traded currencies frequently in the 1970s and 1980s, but recently the Fed and ECB don’t intervene, as they doubt the effectiveness of intervention.
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Japan sold yen worth 10% of GDP in 2003 and 2004 in an effort to stop appreciation and stimulate exports.
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Capital Controls
Capital controls are regulations that restrict capital inflows or outflows.
Both governments and central banks impose capital controls.
Controls take different forms: requiring approval to purchase assets and taxes or forbidding entry into a country.
Capital outflows may be restricted to direct savings toward domestic investment; inflow controls may prohibit foreign ownership of domestic assets.
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Mexico restricts foreign ownership of real estate and natural resources.
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Effects on Exchange Rates
A restriction on capital outflows shifts NCO to the left, and vice versa.
Capital controls ease the trade-off between output and exchange-rate stability.
Capital controls can offset other shocks affecting exchange rates, such as a loss of confidence.
In the 1997-1998 East Asian crisis, most central banks increased interest rates in response to increased capital outflows, causing recessions in their countries.
Alternatively, Malaysia restricted capital outflows and lowered its interest rates, recovering faster than the other affected countries.
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Other Asian countries affected by the crisis raised interest rates and suffered longer recessions.
Figure 17.9 Capital Controls and the Exchange Rate
If Boversia’s government or central bank imposes restrictions on capital outflows, the NCO curve shifts to the left and the exchange rate rises (A). Restrictions on capital inflows have the opposite effects (B).
ε
Bovers
(A) Restrictions on Capital Outflows
NCO 1
NCO 2
ε
Bovers
(B) Restrictions on Capital Inflows
NCO 1
NCO 2
NX
NX
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The Critique of Capital Controls
Economists argue that controls impede the flow of saving to its most productive uses.
Even in cases such as Malaysia, where controls appear to have provided short-run assistance, controls will reduce foreign investment in a country.
The U.S. abolished a tax on foreign asset purchases in 1974, but many developing countries still have controls.
Thailand imposed controls in 2006 to stop its currency from appreciation, but the result was a stock market crash and controls ended.
The Thai case shows a problem with controls.
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Many countries have abolished capital controls.
CHAPTER 17 Monetary Policy and Exchange Rates
Policy Coordination
Appreciation of one currency is also a depreciation of other currencies, so officials of different countries discuss exchange rates because many countries are affected by any change.
In 1985 a strong dollar led to calls for trade restrictions in the U.S., so the U.S., Europe, and Japan signed the “Plaza Agreement” to work to depreciate the dollar.
In 2000, the U.S., Europe, and Japan agreed to try to boost the value of the euro, but intervention didn’t have much effect on exchange rates, explaining why the Fed and ECB don’t intervene.
Since the effects of intervention are questionable and interest rate adjustments may be necessary, central banks prefer freedom to set interest rates and thus don’t make exchange-rate commitments.
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In 2003-2004 U.S. officials criticized Japan which intervened to weaken the yen, because U.S. officials wanted a stronger yen to increase demand for U.S. exports.
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Fixed Exchange Rates
A floating exchange rate is a policy that allows the exchange rate to fluctuate in response to economic shocks.
A fixed exchange rate is a policy that holds the exchange rate at a constant level.
Fixed exchange rates better promote international trade and capital flows since this policy eliminates exchange-rate risk.
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Most central banks allow exchange rates to float due to the drawbacks of the policies used to control exchange rates.
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Mechanics of Fixed Exchange Rates
Assume Boversia fixes the value of its currency to the dollar at 2 bovers per dollar.
To keep the price fixed it buys and sells dollars which is foreign-exchange intervention.
If capital flight occurred, the central bank would sell dollars to support its exchange rate, but it would eventually run out of dollar reserves.
To maintain the exchange rate the central bank must increase interest rates, restrict capital outflows, or both, or else the exchange rate will fall.
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A country’s ability to support its currency is limited by its international reserves.
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Devaluation and Revaluation
A fixed exchange rate is a nominal rate, e.
Real exchange rates, ε, matter for the economy:
ε = eP/P*
where P is the domestic price level and P* is the foreign price level.
A fixed nominal rate does not fix the real rate, since price levels can change.
An increase in the domestic price level, with a fixed nominal rate, increases the real exchange rate, reducing net exports and output.
An increase in the foreign price level reduces the real exchange rate and makes imports more expensive, hurting consumers.
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Net exports are determined by real, not nominal, exchange rates.
CHAPTER 17 Monetary Policy and Exchange Rates
Devaluation and Revaluation
Countries change fixed exchange rates to offset the effects of price level changes.
Devaluation is resetting of a fixed exchange rate at a lower level.
Revaluation is resetting of a fixed exchange rate at a higher level.
A devaluation or revaluation fixes the exchange rate at a new level.
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Devaluation lowers the real exchange rate.
A Fixed Exchange Rate: Pros and Cons
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Insert table 17.2 here.
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CHAPTER 17 Monetary Policy and Exchange Rates
Loss of Independent Monetary Policy
A benefit of fixed exchange rates is the encouragement of international trade and capital flows.
The costs of fixed exchange rates are the policies that must be used to control the exchange rate: capital controls or interest rate adjustments.
If interest rates are used to stabilize exchange rates, they cannot be used to stabilize the economy.
The central bank cannot change the interest rate to offset expenditure shocks because doing so would change the exchange rate.
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With fixed exchange rates, monetary policy cannot be used to stabilize the economy.
CHAPTER 17 Monetary Policy and Exchange Rates
Loss of Independent Monetary Policy
If interest rates increase in the U.S., NCOs will increase in Boversia unless the interest rate is increased in Boversia.
Thus, the Fed sets the interest rate in Boversia.
The economic conditions in the U.S. may differ from those in Boversia, making U.S. policy inappropriate for Boversia.
The U.S. may raise rates to stop a boom, while higher rates worsen Boversia’s recession.
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With fixed exchange rates, small countries relinquish their monetary policies to a large country.
CHAPTER 17 Monetary Policy and Exchange Rates
Controlling Inflation
Loss of monetary independence is a cost of fixed exchange rates.
A fixed exchange rate is a monetary rule that can prevent high inflation.
Inflation in Boversia will move close to the U.S. inflation rate.
Higher initial inflation in Boversia increases its real exchange rate, reducing net exports, real output, and lowering inflation to the U.S. level.
Fixed exchange rates can be used to stabilize inflation.
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In the 1980s Israel fixed its exchange rate to the dollar in conjunction with other policies to reduce inflation.
Figure 17.10 Fixed Exchange Rates and Inflation
Boversia fixes its exchange rate against U.S. dollar
If inflation in Boversia > inflation in the United States…
Boversia’s real exchange rate
Boversia’s net exports
Boversia’s inflation rate
AE
Y falls below Y*
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The Instability of Fixed Exchange Rates
Eventually policymakers change the value of fixed exchange rates or switch to floating rates.
The process of reducing inflation through fixed exchange rates requires a recession, which is painful.
People may expect the central bank will devalue the exchange rate rather than continue the recession.
Since devaluation hurts foreign owners of domestic assets, capital flight occurs in the high-inflation country.
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Expectations of devaluation are a one-way bet against a fixed exchange rate.
Figure 17.11 The Instability of Fixed Exchange Rates
If Boversia’s real exchange rate is high, reducing output…
people expect devaluation of the bover, which will cause losses to foreign owners of Boversian assets
capital flight from Boversia
r needed to prevent Boversia’s exchange rate… but this would Y
Boversia’s central bank devalues
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CHAPTER 17 Monetary Policy and Exchange Rates
The Instability of Fixed Exchange Rates
Capital flight depletes a central bank’s international reserves, forcing an increase in interest rates or a devaluation.
Expectations of devaluation are self-fulfilling.
Currency speculation helps cause devaluations.
A speculative attack is the strategy of selling a currency with a fixed exchange rate, to force and profit from a devaluation.
The goal of fixed exchange rates is to stabilize the exchange rate, but speculative attacks cause large, sudden changes in exchange rates.
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A speculative attack is an attempt to force a policy change on a central bank.
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A Brief History of Fixed Exchange Rates
The gold standard was a system of fixed exchange rates in which each country fixed the value of its currency in terms of gold; the gold standard broke down during the Great Depression.
Forty-four countries established the Bretton Woods system of fixed exchange rates in 1944.
Fixed rates were believed to be essential for trade.
Interest-rate adjustments, capital controls, and interventions would maintain fixed rates.
U.S. inflation caused a real appreciation, causing people to expect a U.S. devaluation.
In 1971 a speculative attack forced an 8% devaluation of the dollar and another attacked on the U.S. dollar resulted in a 10% devaluation in 1973.
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In the 1950s Milton Friedman began advocating floating exchange rates.
CHAPTER 17 Monetary Policy and Exchange Rates
A Brief History of Fixed Exchange Rates
Rates “temporarily” floated after the 1973 attack, but fixed rates were never restored, since floating rates allow for independent monetary policies and avoid speculative attacks.
Since 1973 most advanced countries have had floating rates as they prefer independent monetary policies.
Europe’s ERM was an exception but that was a temporary step toward the euro.
In the 1970s through the 1990s, many developing countries fixed their exchange rates to the U.S. dollar, but speculative attacks forced many of these countries to float their exchange rates.
Today small countries with links to larger economies have fixed exchange rates as do oil exporters who fix exchange rates to the U.S. dollar.
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The world price of oil is set in terms of dollars, so the fixed exchange rate stabilizes the flow of revenues to the oil producers.
CHAPTER 17 Monetary Policy and Exchange Rates
Currency Unions
A currency union is a group of countries that has adopted a single money, an extreme version of fixed exchange rates.
The euro is a currency union created by 11 countries in 1999 and used by 17 countries in 2011.
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The euro area is the world’s largest currency union.
CHAPTER 17 Monetary Policy and Exchange Rates
The Euro Area
The Exchange Rate Mechanism was created in 1992 to reduce fluctuations and ultimately fix exchange rates, leading to the euro in 1999.
To adopt the euro, countries must be members of the European Union and have good economic policies.
The policy requirements include a budget deficit less than 3% of GDP and low inflation.
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The Maastricht Treaty was the agreement creating the euro.
The Birth of the Euro
In 1999 15 countries belonged to the European Union, but only 11 adopted the euro.
Two countries, Sweden and Greece, did not meet the economic criteria to join the euro, and England and Denmark chose not to join.
A goal of the European Union is economic integration, including removal of trade barriers and capital controls.
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The single currency facilitates price comparisons between countries.
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CHAPTER 17 Monetary Policy and Exchange Rates
The Euro Area Grows
Greece met the economic criteria in 2001 and joined the euro.
Between 2004 and 2007 the EU admitted 12 new countries; as of 2011 five have joined the euro: Slovenia, Slovakia, Estonia, Cyprus, and Malta.
Other new members are eager to join, but some do not yet meet the economic criteria.
The U.K., Denmark, and Sweden remain outside the union.
The public in Denmark and Sweden recently voted to retain their national currencies.
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All of the new EU members must eventually join the euro.
CHAPTER 17 Monetary Policy and Exchange Rates
European Monetary Policy
The Eurosystem runs monetary policy for the euro area.
The European Central Bank (ECB) has a six-member Executive Board.
The president of the ECB chairs the Board and serves a single eight-year term.
Monetary policy sets interest-rate targets at monthly meetings of the Governing Council, comprised of the Executive Board and 15 governors from countries’ national central banks (NCBs).
As the euro area includes more than 15 countries and will expand further, governors of NCBs will take turns on the Council.
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The NCBs perform functions similar to the Federal Reserve Banks in the United States.
Figure 17.12 The Euro Area, 2011
The countries shaded in orange used the euro as their currency in 2011.
SWEDEN
NORWAY
DENMARK
NETHERLANDS
LUXEMBOURG
BELGIUM
GERMANY
POLAND
BELARUS
UKRAINE
CZECH REPUBLIC
SLOVAKIA
AUSTRIA
SLOVENIA
ITALY
SWITZERLAND
FRANCE
SPAIN
PORTUGAL
MOROCCO
ALGERIA
TUNISIA
MALTA
CYPRUS
GREECE
BULGARIA
SERBIA
BOSNIA AND HERZEGOVINA
ROMANIA
HUNGARY
LITHUANIA
LATVIA
ESTONIA
FINLAND
UK
IRELAND
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CHAPTER 17 Monetary Policy and Exchange Rates
The Economics of Currency Unions
A currency union increases economic integration that promotes trade and capital flows.
A currency union has several advantages:
Exchange rates are absolutely fixed at 1:1, and speculative attacks are impossible.
The costs of exchanging currencies is eliminated.
Price comparisons in different countries are facilitated, increasing competition.
Research has found that integration has increased, as have capital flows.
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The euro’s creators hoped the euro would increase integration and speed economic growth.
CHAPTER 17 Monetary Policy and Exchange Rates
One-Size-Fits-All Policy
The drawback of currency unions is the loss of independent monetary policy.
Critics argue that different areas in Europe require different interest rates:
The 2010 Greek debt crisis required increased interest rates, resulting in a recession with 12% unemployment.
If Greece had its own currency, it could loosen monetary policy, depreciating the currency, increasing net exports and helping the recovery, but being a euro member prevents this.
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The United States is a currency union for its 50 states, and different states at times would benefit from independent monetary policies.
CHAPTER 17 Monetary Policy and Exchange Rates
The Politics of Currency Unions
The creation of the euro is part of a political movement toward European unity that began after World War II.
A goal of unity is to avoid future conflicts.
Eastern European countries view the euro as breaking with their Communist past and a tie with Western Europe.
Nationalists who prefer to maintain national identity oppose the euro as a threat to countries’ identity.
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One reason the UK has opted out of the euro is due to a desire to remain independent.
CHAPTER 17 Monetary Policy and Exchange Rates
More Currency Unions?
There are two currency unions in Africa and one in the Eastern Caribbean.
Other unions have been proposed; however, opposition remains strong.
The winner of the 1999 Nobel Prize in Economics, Robert Mundell, has proposed a world currency.
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A world currency would require a world central bank.
CHAPTER 17 Monetary Policy and Exchange Rates
Chapter Summary
Shocks such as shifts in asset holders’ confidence cause fluctuations in exchange rates, destabilizing output and inflation.
Central banks adjust interest rates to offset the effects of exchange rates on output and inflation.
In countries with high levels of foreign trade, such as Canada, adjustments to exchange-rate movements are a major part of monetary policy.
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Chapter Summary
Exchange rate fluctuations create risk for importers and exporters of goods and owners of foreign capital.
Exchange rate risk decreases international trade and capital flows, reducing economic efficiency and international trade.
CHAPTER 17 Monetary Policy and Exchange Rates
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CHAPTER 17 Monetary Policy and Exchange Rates
Chapter Summary
Central banks have several tools to stabilize exchange rates, but each has drawbacks.
Adjusting interest rates stabilizes exchange rates, but may destabilize output.
Central banks try to influence exchange rates with foreign-exchange interventions, but the effectiveness of this policy is questionable.
Capital controls help control exchange rates, but impede the flow of savings to the most productive uses.
Exchange-rate policies can be coordinated, but this may cause frictions.
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Chapter Summary
A central bank fixes its nominal exchange rate by buying and selling its currency at a fixed rate and supports the exchange rate with interest-rate adjustments and/or capital controls.
Policymakers devalue or revalue fixed exchange rates.
Changing the exchange rate offsets drift due to different inflation rates.
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CHAPTER 17 Monetary Policy and Exchange Rates
Chapter Summary
Countries with fixed exchange rates sacrifice independent monetary policies and cannot adjust interest rates to stabilize output.
Fixed exchange rates prevent high inflation by tying a country’s inflation rate to that of another country.
Speculative attacks cause a collapse of fixed exchange rates.
From 1944 to 1973 most countries had fixed exchange rates as members of the Bretton Woods system and have adopted floating exchange rates since then.
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CHAPTER 17 Monetary Policy and Exchange Rates
Chapter Summary
A currency union is a group of countries with a common currency.
The euro area is the world’s largest currency union.
The primary advantage of currency unions is promotion of economic integration; the primary drawback is a single monetary policy that might not be appropriate for all countries, as illustrated by Greece’s 2010 debt crisis.
The impetus for the euro was political: a common currency symbolizes European unity.
Monetary Policy & Exchange Rates
