Comment on the extent to which the international competitiveness of the PIIGS economies can be tackled by monetary policy (10

marks) The lack of competitiveness of the PIIGS economies may be largely due to high inflationary pressure and rising relative unit labour costs, in which case, monetary policy could be effective in restoring the international price competitiveness of PIIGS economies. An increased base interest rate - and, by extension, the expectation of higher interest rates would help to control currently high inflation in the PIIGS economies. Lower inflation, relative to that of the economies trading partners, would cause the price of exports from these economies to fall, somewhat restoring the international competitiveness of the PIIGS. Moreover, lower inflation may cause a fall in relative unit labour costs. This would reduce the PIIGS output prices; further lowering the price of their exports in international markets, and increasing the PIIGS firms ability to compete against imports in the domestic markets. However, there are significant problems with this. Firstly, as the PIIGS economies are part of the Euro single currency, they do not have the freedom to control monetary policy within their economies. The European Central Bank sets interest rates in order to control inflation across the Euro, meaning that conflictions in what is best for the PIIGS economies and the rest of the Euro zone economies would prevent this from happening. Furthermore, a higher interest rate would cause a fall in consumption in the PIIGS economies, and would discourage investment. As these are both significant components of aggregate demand, such a rise in interest rates would reduce or dispel economic growth, and could cause the PIIGS to experience a double dip recession; or in the case of Ireland and Portugal prolong their current recession. None of the PIIGS economies have the fiscal freedom to increase government spending in order to offset such a fall in short run growth, thus such a rise in interest rates at the present time could be terminal for their economies. Alternatively, the PIIGS could choose to leave the Euro single currency and to use their own, new currencies. This would tackle the problem of an overvalued exchange rate and allow their currencies to depreciate. Also, this would give them the freedom to use monetary policy to tackle rising inflation and high relative unit labour costs. Such a move would be extremely expensive to the PIIGS economies, and considering their vast budget deficits, may be out of the question. Moreover, such a move could cause economic instability and a loss of confidence in the economies, which potentially would jeopardise the economic recovery of the PIIGS. Finally, the use of monetary policy would only be effective in tackling international competitiveness if high inflation is a major contributor to their lack of competitiveness. Rising relative unit labour costs indicates that wages are rising faster than productivity This could mean that it is due to the lack of essential supply side reforms in PIIGS economies. Portugal, Italy, Ireland, Greece and Spain are somewhat characterized by their over generous welfare systems and large state sectors. In this case, In order to fully tackle the problem, the PIIGS will need to undergo crucial reforms such as tax and benefit reform, trade union reform and privatisation in order to restore efficiency in their economies and to see real decreases in relative unit labour costs.