🇪🇺 EUROPEAN ECONOMIC
GOVERNANCE
Complete Exam Study Guide | Dr. Francesco Corti
8 Lectures • 10 Open Questions • 20 Points
📋 HOW TO USE THIS GUIDE
✅ Each section = one lecture. Read the summary, then test yourself with the practice Q&A at
the end.
✅ Exam format: 10 open questions × 2 points each = 20 points total.
✅ Focus on: definitions, key mechanisms, historical examples, and the logic of each reform.
✅ Key reference: De Grauwe (2022) The Economics of Monetary Union + class slides.
✅ Tip: master the 4 OCA Rules, the SGP, the crisis sequence, and the 2024 reform — these
are the most exam-likely topics.
, LECTURE 1 — Costs & Benefits of Monetary Union
1.1 What is EU Economic Governance?
EU economic governance is a system of institutions and procedures to coordinate member states'
economic policies. It relies on monitoring, preventing and correcting economic trends that could weaken
individual economies or cause spillovers. Three main benefits:
• Ensures soundness and sustainability of public finances in the medium and long term
• Promotes sustainable economic growth and convergence
• Addresses macroeconomic imbalances through reforms and investments
1.2 What is the EMU?
The Economic and Monetary Union (EMU) has two main pillars:
• Economic Union: coordination of national fiscal/economic policies (mainly via the European
Semester)
• Monetary Union: a single monetary policy for the euro area, set by the independent ECB
Complemented by: Banking Union (harmonised rules, centralised supervision/resolution) and Capital
Markets Union (private risk-sharing, improved access to funding).
1.3 Benefits of a Common Currency
• Elimination of transaction costs (no exchange rate commissions)
• Price transparency (reduces price discrimination, promotes market integration)
• Greater economic certainty (exchange-rate stability improves investment/consumption decisions)
• Lower interest rates (reduced risk premium in a larger, more stable economy)
• Higher economic growth (larger markets, more economies of scale, better information)
• International currency status (additional revenues, international reserve function)
1.4 Costs of a Common Currency
Joining a monetary union means giving up key national instruments. The central challenge: how do
countries adjust to asymmetric shocks without their own currency?
• Loss of national monetary policy (cannot devalue to restore competitiveness)
• Loss of monetary financing of public debt (no independent central bank)
• Risk of negative spillovers from weaker members (competitive internal devaluation)
• Risk of a too-strong or too-weak exchange rate on global markets
1.5 Optimum Currency Area (OCA) Theory — Mundell (1961)
, The OCA theory asks: when is it beneficial for countries to share a currency? The key adjustment
mechanisms if an asymmetric shock hits are: (1) factor mobility, (2) wage/price flexibility, (3) fiscal
transfers, (4) diversified economies.
⚠ THE 4 RULES OF AN OPTIMUM CURRENCY AREA (MUST KNOW)
Rule 1 — Labour Flexibility: The more flexible prices are and the more mobile labour is, the
stronger the monetary union.
Rule 2 — Business Cycle Synchronisation: The more synchronised the economies, the stronger
the monetary union.
Rule 3 — Debt Discipline: Countries need either to maintain low levels of debt OR to have
mechanisms to share debt (or both).
Rule 4 — Common Safe Asset: A monetary union with integrated capital markets requires a
common safe asset to avoid bank-sovereign doom-loops.
1.6 The Doom Loop and Boom-Bust Dynamics
In a monetary union without a lender of last resort, panic-selling of sovereign bonds leads to a self-
fulfilling crisis. Banks holding government bonds go into trouble; governments must bail out banks,
which increases public debt, worsening bond prices — a 'doom loop'.
1.7 Costs vs. Benefits — Key Determinants
• Degree of openness: very open economies benefit more from monetary union (lower inflation
impact of exchange rate moves)
• Wage/price rigidity: high rigidity = higher costs in a monetary union (less adjustment capacity)
• Labour mobility: greater mobility reduces costs by facilitating adjustment
• Completeness of the union: a budgetary union (fiscal transfers) lowers costs significantly
• Political considerations: public support (permissive consensus) can override economic
calculations
1.8 OCA Critique
Krugman (1991): risk of regional concentration means a sector shock becomes a country shock
(divergence). But the European Commission (1990) argued more integration → more symmetry →
fewer asymmetric shocks. Frankel & Rose (1998): closer trade linkage → more synchronised business
cycles (endogeneity of OCA criteria).
GOVERNANCE
Complete Exam Study Guide | Dr. Francesco Corti
8 Lectures • 10 Open Questions • 20 Points
📋 HOW TO USE THIS GUIDE
✅ Each section = one lecture. Read the summary, then test yourself with the practice Q&A at
the end.
✅ Exam format: 10 open questions × 2 points each = 20 points total.
✅ Focus on: definitions, key mechanisms, historical examples, and the logic of each reform.
✅ Key reference: De Grauwe (2022) The Economics of Monetary Union + class slides.
✅ Tip: master the 4 OCA Rules, the SGP, the crisis sequence, and the 2024 reform — these
are the most exam-likely topics.
, LECTURE 1 — Costs & Benefits of Monetary Union
1.1 What is EU Economic Governance?
EU economic governance is a system of institutions and procedures to coordinate member states'
economic policies. It relies on monitoring, preventing and correcting economic trends that could weaken
individual economies or cause spillovers. Three main benefits:
• Ensures soundness and sustainability of public finances in the medium and long term
• Promotes sustainable economic growth and convergence
• Addresses macroeconomic imbalances through reforms and investments
1.2 What is the EMU?
The Economic and Monetary Union (EMU) has two main pillars:
• Economic Union: coordination of national fiscal/economic policies (mainly via the European
Semester)
• Monetary Union: a single monetary policy for the euro area, set by the independent ECB
Complemented by: Banking Union (harmonised rules, centralised supervision/resolution) and Capital
Markets Union (private risk-sharing, improved access to funding).
1.3 Benefits of a Common Currency
• Elimination of transaction costs (no exchange rate commissions)
• Price transparency (reduces price discrimination, promotes market integration)
• Greater economic certainty (exchange-rate stability improves investment/consumption decisions)
• Lower interest rates (reduced risk premium in a larger, more stable economy)
• Higher economic growth (larger markets, more economies of scale, better information)
• International currency status (additional revenues, international reserve function)
1.4 Costs of a Common Currency
Joining a monetary union means giving up key national instruments. The central challenge: how do
countries adjust to asymmetric shocks without their own currency?
• Loss of national monetary policy (cannot devalue to restore competitiveness)
• Loss of monetary financing of public debt (no independent central bank)
• Risk of negative spillovers from weaker members (competitive internal devaluation)
• Risk of a too-strong or too-weak exchange rate on global markets
1.5 Optimum Currency Area (OCA) Theory — Mundell (1961)
, The OCA theory asks: when is it beneficial for countries to share a currency? The key adjustment
mechanisms if an asymmetric shock hits are: (1) factor mobility, (2) wage/price flexibility, (3) fiscal
transfers, (4) diversified economies.
⚠ THE 4 RULES OF AN OPTIMUM CURRENCY AREA (MUST KNOW)
Rule 1 — Labour Flexibility: The more flexible prices are and the more mobile labour is, the
stronger the monetary union.
Rule 2 — Business Cycle Synchronisation: The more synchronised the economies, the stronger
the monetary union.
Rule 3 — Debt Discipline: Countries need either to maintain low levels of debt OR to have
mechanisms to share debt (or both).
Rule 4 — Common Safe Asset: A monetary union with integrated capital markets requires a
common safe asset to avoid bank-sovereign doom-loops.
1.6 The Doom Loop and Boom-Bust Dynamics
In a monetary union without a lender of last resort, panic-selling of sovereign bonds leads to a self-
fulfilling crisis. Banks holding government bonds go into trouble; governments must bail out banks,
which increases public debt, worsening bond prices — a 'doom loop'.
1.7 Costs vs. Benefits — Key Determinants
• Degree of openness: very open economies benefit more from monetary union (lower inflation
impact of exchange rate moves)
• Wage/price rigidity: high rigidity = higher costs in a monetary union (less adjustment capacity)
• Labour mobility: greater mobility reduces costs by facilitating adjustment
• Completeness of the union: a budgetary union (fiscal transfers) lowers costs significantly
• Political considerations: public support (permissive consensus) can override economic
calculations
1.8 OCA Critique
Krugman (1991): risk of regional concentration means a sector shock becomes a country shock
(divergence). But the European Commission (1990) argued more integration → more symmetry →
fewer asymmetric shocks. Frankel & Rose (1998): closer trade linkage → more synchronised business
cycles (endogeneity of OCA criteria).
