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Transmission Of Disturbances And International Policy Coordination And Currency Crises And International Monetary Reform Notes

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The benefits of a common currency o Mostly situated at a micro level (costs mainly at a macro level) o Direct gains from the elimination of transaction costs
 Costs of exchanging currency

EC Commission estimates these gains at between 13 and 20 billion euros a year (0.25-0.5% of Community GDP)

But this is a source of revenue for banks (about 5% of their revenue) which will disappear o But transaction costs are a DWL, banks must look for other profitable activities

Cross-border bank transfers follow a different, and more expensive, route than bank transfers within the same country o Banks are regulated to charge the same prices for these cross border transactions to similar national payments (including e.g. ATM withdrawals) o Indirect gains from the elimination of transaction costs
 Greater price transparency - increase competition

Much evidence that price discrimination is still practised widely in Europe o E.g. supermarket products - intra-country price differentials are 5-10 times lower than inter-country price differentials

'Borders are quite powerful in segmenting markets and in introducing large differentials in prices.'

Why does the introduction of the Euro appear to be a weak force in bringing about price convergence?
o Must be to do with inefficiencies at the retail level, where transaction costs are high.
 Retail business is still very segmented nationally - supermarket chains are still very much national companies
 Regulations/customs/languages and cultures o Might conclude that euro is likely to lead to price convergence through economic integration rather than increasing price transparency

o Welfare gains from less uncertainty
 See Figure 3.2 pg 69

Under price certainty, p1 is guaranteed Under price uncertainty, price fluctuates randomly, assume price fluctuates symmetrically between p2 and p3 Price certainty - profit given by shaded area minus area FGp1 Price uncertainty - profit fluctuates depending on price. BUT profit is larger on average under uncertainty P3EBp1 (profit higher by this area than in certainty case when high price) is greater than p1BCp2 (profit lower by this area than in certainty case when lower price)

o When price is high, firm increases output to profit from higher revenue per unit - higher profit per unit AND more units o When price is low, firm reduces output - limits reduction in total profits o Some complications:
 Imperfect competition
 Adjustment costs
 Potential of losses and being forced to close down o Unclear whether welfare declines (due to increase risk) or increases (due to increased average profit)?
o Uncertainty 'creates opportunities to make profits' o Also positive effect of price uncertainty on average CS - can reduce demand when high price etc. o Exchange rate uncertainty and the price mechanism
 Economic agents base production/consumption/investment decisions on the information that the price system provides - if this is more uncertain the quality of these decisions will decline o Exchange rate uncertainty and economic growth
 Figure 3.5
 f(k) is production function
 slope of rr equal to discount rate
 equilibrium obtained where MPK = the IR consumers use to discount future consumption (point A)
 growth can only occur if the population grows or if there is an exogenous rate of technical change
 elimination of ER risk - lowers real IR - investors require a lower risk premium to make the same investment
 makes rr line flatter
 eq. moves from A to B
 accumulation of capital and increase in growth rate

output per worker and capital stock have increased

growth rate of output then returns to original level (determined by exogenous rate of technological change and population growth)

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