The Decision to join a Currency Area Putting the GG and LL Schedules Together

Figure 20-6 combines the GG and LL schedules to show how Norway should decide whether to fix the krone's exchange rate against the euro. The figure implies that Norway should do so if the degree of economic integration between Norwegian markets and those of the euro zone is at least equal to 9,, the integration level determined by the intersection of GG and LL at point 1.

Let's see why Norway should peg to the euro if its degree of economic integration with euro zone markets is at least 0,. Figure 20-6 shows that for levels of economic integration below 8j the GG schedule lies below the LL schedule. Thus, the loss Norway would suffer from greater output and employment instability after joining exceeds the monetary efficiency gain, and the country would do better to stay out.

When the degree of integration is 0, or higher, however, the monetary efficiency gain measured by GG is greater than the stability sacrifice measured by LL, and pegging the krone's exchange rate against the euro results in a net gain for Norway. Thus the intersection of GG and LL determines the minimum integration level (here, 8,) at which Norway will desire to peg its currency to the euro.

The GG-LL framework has important implications about how changes in a country's economic environment affect its willingness to peg its currency to an outside currency area. Consider, for example, an increase in the size and frequency of sudden shifts in the demand for the country's exports. As shown in Figure 20-7, such a change pushes LL1 upward to LL2: At any level of economic integration with the currency area, the extra

The downward sloping LL schedule Economic stability shows that a country's economic loss for the i°'nin9 country stability loss from joining a fixed exchange rate area falls as the country's economic integration \

with the area rises. \

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