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It is for the peripheral economies.

There is a tradeoff inherent in a currency union: You reduce your ForEx risk, but you have to accept a higher inflation target, because you encompass a larger area with more variation in price level and in price changes. A higher baseline inflation both reduces the distortion inherent in these differences, and allows countries to temporarily pursue low inflation as a way to get out-of-line price levels back in line with the majority.

Greater economic and political integration can make the inflation cost of a currency union smaller, but it probably can't make it go away entirely.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue May 18th, 2010 at 07:47:46 AM EST
[ Parent ]
I think inflation is related to the volatility of cash flows (in a fluctuation-dissipation kind of way). This would mean the larger the currency area the higher the inflation.

By laying out pros and cons we risk inducing people to join the debate, and losing control of a process that only we fully understand. - Alan Greenspan
by Migeru (migeru at eurotrib dot com) on Tue May 18th, 2010 at 08:20:03 AM EST
[ Parent ]
>Greater economic and political integration can make the inflation cost of a currency union smaller, but it probably can't make it go away entirely.

A currency union governed as is the current practice within the euro-zone is likely to impose a debt-deflation spiral cost that could make everything go away. The only countries that have any recent experience of real deflation are those that have been the beneficiaries of the IMF's policies following IMF largess, now imitated inside the euro-zone for Greece, Ireland and Latvia. Given political realities, a debt-deflation spiral may be the only way the massive bad debt now mingled into the financial system will be written down.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue May 18th, 2010 at 09:38:41 AM EST
[ Parent ]
Pain, pain!

By laying out pros and cons we risk inducing people to join the debate, and losing control of a process that only we fully understand. - Alan Greenspan
by Migeru (migeru at eurotrib dot com) on Tue May 18th, 2010 at 09:46:37 AM EST
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