Saturday, 7 May 2011
Why is it necessary for interest rates to be set centrally in a monetary union?
In a monetary union such as the eurozone, interest rates are always set by a central bank and the rate they choose applies for the whole area. The reason the rate has to be the same in each country is because if one country had a higher rate of interest than all of the others, then it could well lead to a lack of convergence of the economic cycles, as high levels of interest rates would restrict growth in one economy where another economy may have low levels and be growing quickly. The reason given by the ECB is that it is in their interest to promote "Price Stability" and a single interest rate makes this much easier, mainly because interest rates are a tool used to control inflation.
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You say: "The reason the rate has to be the same in each country is because if one country had a higher rate of interest than all of the others, then it could well lead to a lack of convergence of the economic cycles, as high levels of interest rates would restrict growth in one economy where another economy may have low levels and be growing quickly."
ReplyDeleteIf one country had higher inflation AND higher interest rates why would this lead to a lack of convergence? Surely if the SAME interest rates is levied for two countries that have different rates of inflation then THIS will lead to a lack of convergence?
Presumably the ECB doesn't trust the individual countries to make interest rate decisions that promote price stability, they would perhaps instead choose to lower interest rates despite high inflation if unemployment is high.
ReplyDeleteSpain right now, for example, if it could control its interest rate, would almost certainly reduce it in the interest of reducing its 25% unemployment rather than trying to control the price level
But a high level of unemployment surely slows growth (low income, low demand) and that in itself causes a lack of convergence?
ReplyDeleteNo answer?
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