1. The New Europe
Dale R. DeBoer, PhD
CU-Colorado Springs

2. Optimal Currency Area
• Outgrowth of the work of Robert Mundell
(1961)
• Requirements for a geographic region to
operate under a single currency

3. Why do it?
• Reduced transactions costs
• Greater gains from trade
• Potential to challenge the dollar as the
international reserve currency

4. Requisites for an OCA
• Labor mobility
• Why?
• Legal restrictions
• Cultural restrictions

5. Requisites for an OCA
• Labor mobility
• Financial capital mobility

6. Requisites for an OCA
• Labor mobility
• Financial capital mobility
• Wage and price flexibility

7. Requisites for an OCA
• Labor mobility
• Financial capital mobility
• Wage and price flexibility
• Fiscal transfer mechanism

8. Requisites for an OCA
• Labor mobility
• Financial capital mobility
• Wage and price flexibility
• Fiscal transfer mechanism
• Synchronized business cycles

9. Steps towards an OCA
Source: “Treaties of the European Union.”
https://en.wikipedia.org/wiki/Treaties_of_the_European_Union. Downloaded February 12, 2013

10. Steps towards an OCA
• European Economic Community (1957)
• Belgium, France, Italy, Luxembourg,
Netherlands, and West Germany
• Customs union
• Price unification and flexibility
• Removal of legal restrictions on labor and
capital mobility

11. Steps towards an OCA
• European Economic Community (1957)
• Economic and Social Committee (1958)
• Consultative body of unions, employers,
and “special interests”
• The European “3rd way”

12. Steps towards an OCA
• European Economic Community (1957)
• Economic and Social Committee (1958)
• Common Agricultural Policy (1962)

13. Steps towards an OCA
• Economic and Social Committee (1958)
• Common Agricultural Policy (1962)
• European Community (1967)
• Joined with European Coal and Steel
Community and European Atomic Energy
Community
• Planning entities

14. Steps towards an OCA
• European Community (1967)
• European Monetary System (1978-79)
• Spurred by the demise of the Bretton
Woods system
• Exchange rate fluctuation bounds set
• Elimination of legal restrictions on labor
mobility

15. Steps towards an OCA
• European Community (1967)
• European Monetary System (1978-79)
• Single European Currency Act (1987)
• Establishes intention to create a unified
currency

16. Steps towards an OCA
• European Monetary System (1978-79)
• Single European Currency Act (1987)
• Maastricht Treaty (1992)
• Name changed to the European Union
• Single currency implementation strategy
established

17. Steps towards an OCA
• European Monetary System (1978-79)
• Single European Currency Act (1987)
• Maastricht Treaty (1992)
• European Monetary Institute (1994)
• Established coordinated central bank
actions under the aegis of the ECB

18. Steps towards an OCA
• Growth and Stability Act (1997)
• National debt < 60%
• Budget deficit < 3%
• Inflation < 3.2%
• Long-term interest rates < 7.2%
• Participation in the EMS

19. Early judgement
• Mundell
• “This is in my view a great step
forward ...”
• Friedman
• “I have very low expectations ...”

20. Was it enough?
• Countries
• Belgium, France, Italy, Luxembourg,
Netherlands, Germany, Denmark, Ireland,
Greece, Portugal, Spain, Austria, Finland
• Special cases
• Sweden, United Kingdom

21. Labor mobility
Source: Gakova, Z. and Dijkstra, L. 2008. Labour Mobility
between the Regions of the EU-27 and a Comparison with the US.

22. Labor mobility
Source: Gakova, Z. and Dijkstra, L. 2008. Labour Mobility between
the Regions of the EU-27 and a Comparison with the US.

23. Debt
Source: Eurostat, Google Public Data

24. Debt
Source: Eurostat, Google Public Data

25. Deficits
Source: Eurostat, Google Public Data

26. Deficits
Source: Eurostat, Google Public Data

27. Inflation
Source: Eurostat, Google Public Data

28. Inflation
Source: Eurostat, Google Public Data

29. Unemployment
Source: Eurostat, Google Public Data

30. Unemployment
Source: Eurostat, Google Public Data

31. Unemployment
Source: Eurostat, Google Public Data

32. Business Cycles
Source: Eurostat, Google Public Data

33. Business Cycles
Source: Eurostat, Google Public Data

34. Where did things go
wrong?
• Conditions not met
• Debt
• Deficits

35. Where did things go
wrong?
• Conditions not met
• Theory not satisfied
• Asynchronous business cycles
• Insufficient labor mobility

36. Options for resolution
• Do nothing
• Dissolve the union
• Tighten the union

37. Current situation
Source: Eurostat, Google Public Data
Source: Wall Street Journal,
http://online.wsj.com/article/SB10001424127887324162304578303503840132168.html,
downloaded 2/19/2013.

38. Current situation
Source: Eurostat, Google Public Data

39. Current situation
Source: Eurostat, Google Public Data

40. Do nothing?
• Greek collapse
• Political unrest

41. Dissolve the union?
• No mechanism in place
• Financial market risk

42. Tighten the union?
• Extreme “federalism”

43. Limits on the ECB
• Unified goal
• Medium term inflation no greater than
2%
• Outright Monetary Transactions
• September 2012

44. Current Bailouts
• European Financial Stability Facility
• May 2010
• €440 billion
• Backed by Germany
• Borrowing up to capital invested in ECB

45. Current Bailouts
• European Financial Stabilization Mechanism
• January 2011
• €60 billion
• Bonds guaranteed by the EU

46. Current Bailouts
• Brussels Agreement
• October 2011
• 50% write-off of Greek debt
• Later increased to 53.5%
• Approximately a €100 billion reduction

47. Current Bailouts
• European Stability Mechanism
• October 2012
• “Firewall” action

48. Latest “monkey
wrench”
• Italian election results (or lack thereof)
• February 25, 2013

49. Ramifications for the
US
• Position of the dollar strengthened
• Export market weak
• Financial contagion