F585 - Global economy

Detailed advantages and disadvantages of

- The Maastricht Convergence Criteria

- Single currency

- Foreign Direct Investment (FDI)

- Competitive devaluations

- Flat tax

- Fxed exchange rates

- Floating exchange rates

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  • Created by: Sanchia
  • Created on: 30-05-13 09:51
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Advantages Disadvantages
Maastricht Convergence Criteria
The Maastricht Convergence Criteria is an Real convergence is the similarities in the
effective way of creating monetary structure of economies/ types of
convergence, this refers to similarities in industries. This is not addressed in criteria
inflation, interest rates and the impact of and therefore economic shocks mean that
monetary policies among several countries. countries' economies will react in different
The criteria aims to set inflation at no more ways ­ for instance some countries may
that 1.5% higher than the nations with the be more reliant on FDI or have a larger
lowest inflation, and interest rates no more proportion of homeowners.
than 2% higher than the nation with the
lowest inflation. The lack of real convergence means that
fiscal and monetary convergence targets
This will help to create a convergence in may not be able to be met in the face of
economic cycles and mean that the impact an economic shock e.g. Greece vs.
of monetary transmission mechanisms is Germany
felt similarly across member nations. It may
also mean that countries respond in similar Interwoven
ways to economic shocks.
Fiscal convergence is similarities in the Members have lost control on monetary
administration and impact of fiscal policies. policy and a lack of flexibility on fiscal
Government spending must be no more targets may make it difficult for them to
that 3% of GDP and government debt increase/decrease AD to meet the inflation
must be no more than 60% of GDP. This is target and create price and exchange rate
likely to mean that governments must stability. As a result the Maastricht Criteria
approach fiscal policy is a consistent way, may not be affective in creating fiscal and
both in terms of the positioning of monetary convergence in the long term
automatic fiscal stabilisers as well as and countries will essentially lose control of
discretionary spending decisions. the tools needed to create price and
exchange rate stability
Transition made smoother to join the EU
If countries all in the same place on the
economic cycle, it is easier to manipulate
interest rates/ exchange rates/ fiscal
spending to meet the needs of all the
Single currency
Having a single currency avoids costs and There are technical / menu costs involved
risks from currency fluctuations as there is in converting to a new currency. Literally
less uncertainty on prices. For example to speaking this is the cost of restaurants
cost of materials may change over time printing new menus as there are new
due to the exchange rate, a single currency prices, but it also includes the cost of
avoids this risk and encourages more changing nominal prices in general.
people to invest. (One-off)

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There is an increase in trade from having a Entry to the Euro Zone means a permanent
single currency as all the prices are the transfer of domestic monetary sovereignty
same. Due to having no transaction costs to the European Central Bank. Britain would
and a good price transparency for have less economic power as it is unable to
comparisons there is less risks and less manipulate it's own interest rates, control
barriers to entry.…read more

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One of the motives for FDI is efficiency FDI's are also resource seeking, this refers
seeking, which aims to produce goods and to seeking specific resources which are
services more efficiently (i.e. at lower unit unavailable in the home country, for
cost) than in the home country. Therefore example an overseas company investing in
businesses relocate to find a country with North Sea oil production. Although this may
cheaper labour.…read more

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This can be done by increasing the supply Due to the lack of competition, inefficient
of a currency or lowering the demand for it.
firms will remain in the market. As the price
(graph) of exports are lower than competitors, who
may be more efficient, inefficient firms will
still be able to survive as consumers may
buy the cheapest product.…read more

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The Harrod-Domar model explains that International `race to the bottom' happens
developing economies have low incomes. when countries compete with each other
Low incomes mean you are likely to have a to see who has the lower taxes, to
low saving ratio. Therefore less money is attract foreign firms. Having a fixed rate
invested into businesses to spend on of 21% may means that countries do not
capital. If flat tax follows the example want to stay in Estonia.…read more

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If the exchange rate is set below the
market price the domestic country can
benefit. However this leads to international
retaliation, protectionist measures, trade
restriction and quotas.
Floating exchange rate
A system whereby the price of one currency expressed in terms of another is
determined by the forces of demand and supply
Determined by trade.…read more


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