Practise IB Economics SL 4.4.5 by explaining monetary union, common currency arrangements and their effects on trade, policy and welfare using marked exam evidence.
Study the extract below and answer the questions that follow.
Latvia to join the eurozone monetary union
(1) Latvia will become the 18th country to adopt the euro after being approved for membership by the European Commission. The country has met the criteria for eurozone membership, including low inflation, low long-term interest rates, a stable exchange rate, low public debt and low budget deficits.
(2) Latvia joined the European Union (EU) customs union in 2004. This resulted in a large increase in the availability of credit and strong economic growth in Latvia. However, the 2008 global financial crisis resulted in the collapse of one of its leading banks and massive economic instability. Economic output fell by about 20 % and Latvia had to accept a bailout (loans) from the International Monetary Fund (IMF) and the EU.
(3) Latvia kept the lat (the Latvian currency) pegged to the euro throughout the crisis. At the time, some economists argued that devaluation would have been a better way to improve the economy. However, Latvia followed the path of other countries such as Greece and Ireland, and chose to improve competitiveness through austerity measures. This involved increasing direct taxes and cutting government spending and public sector wages.
(4) By late 2010, the economy was growing again and Latvia had repaid the loans to the IMF and the EU. In 2012, the economy expanded by 5.6 %, the fastest of any country in the EU, although output was still 12 % below its pre-crisis peak. In addition unemployment was falling, but it remained high at 12.4 %.
(5) For Latvia, which shares a border with Russia, the attraction of the euro is about economics and security. Entering the eurozone in January 2014 is part of a process of shifting away from the influence of Russia, and following its northern neighbour Estonia which joined the eurozone in 2011. Lithuania hopes to join the eurozone in 2015.
(6) Public support for joining the eurozone has been low. Evidence from one survey suggests that a small majority of Latvia's population opposes membership, fearing that prices will rise and Latvians will be drawn into the problems facing Europe's struggling economies.
(7) Nonetheless, there are signs that support is growing. The Latvian prime minister said that "switching to the euro will help economic growth and bring increased foreign investment. Unlike countries that can afford to ignore the euro and additional integration, Latvia cannot easily stand on its own. This is good news, not only for Latvia, but also for the eurozone. It shows that there is still confidence in the single currency".
www.theguardian.com, 16 July 2013]
Using information from the text/data and your knowledge of economics, evaluate the possible impact of Latvia joining the eurozone.
Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.
Marking guidance:
Do not award beyond Level 2 if the answer does not contain reference to the information provided.
Level Marks
0 The work does not reach a standard described by the descriptors below. ..... 0
1 Few relevant concepts are recognized. ..... 1-2
There is basic knowledge/understanding.
2 Relevant concepts are recognized and developed in reasonable depth. ..... 3-5
There is clear knowledge/understanding.
There is some attempt at application/analysis.
3 Relevant concepts are recognized and developed in reasonable depth. ..... 6-8 There is clear knowledge/understanding.
There is effective application/analysis.
There is synthesis/evaluation, supported by appropriate theory and evidence.
Command term
"Evaluate" requires candidates to make an appraisal by weighing up the strengths and limitations.
Responses may include:
- definition of monetary union.
Arguments for:
- elimination of exchange rate uncertainty
- easier for future planning by firms
- increased investment and trade
- increased investor confidence
- reduction in transaction costs in trade with the eurozone
- increased foreign investment (paragraph (7)
- increased economic growth (paragraph 7)
- greater integration with the eurozone helps reduce dependence on Russia (paragraph 5)
- renewed confidence in the eurozone will bring benefits to all members (paragraph 7)
- may help to bring down unemployment, which is high (paragraph (4))
- Latvia had to exercise discipline to meet the criteria to join the eurozone which built a good economic foundation for moving forward (paragraph (1)).
Arguments against:
- loss of sovereignty over monetary policy
- possible high changeover costs
- problems of supporting other eurozone members (paragraph 6)
- Latvia loses the power to control its own currency to improve competitiveness
- threat of inflation as well as deflation (paragraph ())
- short term - lower consumer confidence (paragraph 6 ).
Any reasonable evaluation that offers a considered and balanced review of the strengths and limitations of Latvia joining the eurozone.