Optimum currency area-economic Theories

Question 1

Common currency benefits

The bigger the are the bigger the adv. and dis.

Answer 1

• Reduced transaction costs
• No currency uncertainty
• Grater transparency
• interest rate advantage for countries with initially high inflation rates

Question 2

Commun currency costs

Answer 2

if member are different, probability of asymmetric external shocks increases (external events having different affect on counties)

Common monetary policy: member can’t control own interest rate and exchange rates
no possibility to nationally react to external shocks

Question 3

Criteria for an optimum currency area

Answer 3

Minimizing costs and probability of asymmetric external shocks

• Capital mobility +
• labour mobility -
• flexibility of prices and wages -
• high openness of economies and intensive trade relations +
• diversified and similar production and exports +/-
• Similar inflation rate, growth rates.. +/-

question whether there is political support
-fiscal tranfers +/-
homogeneity of national preferences concerning the measures which shall be adopted if an external shock occurs +/-
solidarity +/-

Question 4

Function and role of central banks

Answer 4

• contact the monetary policy of a country / currency area
• issuing banknotes
• conducting operations to influence the money supply (buy & selling currency)
• Holding & managing foreign currencies as reserves
• Establishing rules for banks in the currency area (Minimum reserves requirement, equity requirements)
• supporting government policies

Question 5

Monetary vs. Fiscal Policy

Answer 5

Monetary: change money supply
Fiscal: taxes & duties and / or government spending

Question 6

Monetary theory

Answer 6

• in long rung doesn’t work because of adaption
• fiscal policy doesn’t work (increase movement spending crowds out private investment)

Money supply increase –> inflation increases –> real wages decrease –> demand per labour increase

if workers realize that real wages have decreased they will ask for higher wages –> companies will reduces production –> unemployment rises

Conclusion of monetarist: government shouldn’t interfere on the demand side (only if market failure) but on the supply side (improve condition for employers: reduce tax, reduces labour market regulation)

Question 7

Keynesian theory

Answer 7

1929 Recession, high unemployment rates

Fiscal policy is decisive (monetary policy doesn’t work)
In case of recession governments should increase spending –> employment rises
in case on booms governments should reduce spending and increase taxes

Multiplier effect of government spending: Government should support low income groups with their spending because they have higher propensity to consume (spend higher % of their income on consumption) –> effect of government spending is higher

Groups supported by government spending increase consumption –> production increase –> Employment increase