Lecture 6

• What is an exchange rate?

  An exchange rate is the value of a currency in relation to other currency
• If the rate $/€ decreases, the $ is appreciating against the €
• If the rate €/$ decreases, the € is appreciating against the $
• Exchange Rate

  Value of a currency in relation to another currency
• Euro Appreciation


  Euro's increase in value against another currency
• Exchange Rate Fluctuation

  Variation in the value of a currency over time
• Exchange Rate Regimes


  Systems governing currency valuation like free floating or fixed rates
• Competitiveness

  Ability to sell goods at competitive prices in international markets
• Interest Rate

  Rate at which a lender charges a borrower for money use
• Interest Rate Parity


  Equilibrium condition linking interest rates and exchange rates
• Interbank Rates

  Interest rates used by banks for interbank operations
• Bond Yields

  Returns on bonds, often used as a convergence criterion
• Inflation


  Rise in general prices of goods and services in an economy
• Deflation

  Decrease in general prices of goods and services in an economy
• Consumer Price Index


  Measure of price changes for goods and services consumers buy
• Harmonised Index of Consumer Prices (HICP)

  EU's consumer price index reflecting price changes in euro area
• Asymmetric shocks

  Events causing varied economic impacts in different regions
• Optimum Currency Area (OCA)

  Region sharing a common currency with specific criteria
• Labour mobility


  Ease of movement of workforce across borders
• Product diversification


  Range of products a country specializes in
• Openness

  High trade volume and openness to trade
• Fiscal transfers

  Compensation among countries for adverse shocks
• Homogeneous preferences

  Shared consensus on dealing with economic shocks
• Commonality of destiny

  Belief in a shared future and destiny among countries
• European Central Bank (ECB)

  Central bank for the Eurozone with price stability objective
• Eurozone

  Monetary union of EU countries using the euro
• European Rate Mechanism (ERM)

  System for exchange rate stability before euro adoption
• Euro short-term rate (€STR)

  Reflects euro area banks' overnight borrowing costs
• Interest rate corridor

  Range between deposit and lending rates setting market rates
• Forward guidance

  ECB's communication on future monetary policy intentions
• Net asset purchases

  Buying financial assets to stimulate the economy
• Christine Lagarde

  President of the ECB providing monetary policy insights
• Euro crisis 2010-2013

  Period of uncertainty about the Euro's survival
• Mundell's criterion

  OCA criteria: Labor mobility eliminates currency risk
• Kenen's criterion

  OCA criteria: Diversified production reduces shocks
• McKinnon's criterion

  OCA criteria: Open economies form an OCA
• Exchange rate stability criterion

  Requirement for ERM membership before euro adoption
• European System of Central Banks (ESCB)

  Broader system including the ECB for monetary policy
• European Financial Stability Fund

  Established post-debt crisis for financial stability
• Next Generation EU

  EU's recovery plan post-Covid-19 crisis