Optimum currency models

Question 1

What is the European Union?

Answer 1

The European Union as a group of 27 countries who operate under the same governed business rules and utilise a common currency, the euro.

Question 2

What were 3 goals of the founders of the EMS and EU?

Answer 2

• To enhance Europe’s power in international affairs
• To make Europe a unified market
• To make Europe politically stable and peaceful

Question 3

What is the definition of a monetary union?

Answer 3

A monetary union is when two or more countries adopt a common currency, with a common central bank setting one interest rate

Question 4

What is a main cost of a monetary union?

Answer 4

The main cost of a monetary union is that it means governments cannot use monetary policy to deal with macroeconomic shocks

Question 5

When are asymmetric shocks most costly?

Answer 5

This drawback becomes most costly when labour mobility and wage flexibility are low.

Question 6

What is an alternative adjustment mechanism under a monetary union?

Answer 6

Under a monetary union, an alternative adjustment mechanism is utilising wage flexibility and labour mobility

Question 7

Under a negative AD shock, what happens under flexible wage markets?

Answer 7

Under a negative AD shock, under flexible wage markets, AD shifts to the left, prices fall, and business lower wages and other factors of production costs, shifting AS to the right.

Question 8

Where is labour mobility very limited and for whom and what reason?

Answer 8

Labour mobility is very limited for low-income workers due to government benefits and handouts meaning people are unlikely to switch jobs.

Question 9

Under what circumstance may it be better for a country to stay out of a monetary union rather than get into one?

Answer 9

It may be better for a country to stay out of a monetary union if their wage flexibility and labour mobility are both low.

Question 10

What are the two conditions which if satisfied make a currency union viable?

Answer 10

Wage flexibility and labour mobility must be high in order for a currency union to be viable.

Question 11

What is another major drawback to governments of joining a monetary union?

Answer 11

Another major drawback to governments of joining a monetary union is that they lose their monetary independence and this affects their ability to deal with asymmetric shocks

Question 12

What is a country that has rejected a monetary union in favour of it’s own currency?

Answer 12

The UK is a country that has rejected a monetary union in favour of it’s own currency, the Pound.

Question 13

How is a liquidity crisis triggered?

Answer 13

A liquidity crisis is triggered when the government can no longer make loans to cover its budget deficits

Question 14

Monetary unions can be especially fragile when hit by … shocks

Answer 14

Monetary unions can be especially fragile when hit by large asymmetric shocks

Question 15

What is a solution to the drawbacks of a monetary union?

Answer 15

A solution to the drawbacks of a monetary union is to create a common union budget, known as a budgetary union

Question 16

What is a benefit of a Budgetary union?

Answer 16

It creates an insurance mechanism that triggers income transfers from the country experiencing good times to the countries experiencing bad times

Question 17

What are three criticism levels of OCA theory?

Answer 17

• How relevant are the differences between countries and should we worry?
• Is national monetary policy effective?
• How credible are national monetary policies?

Question 18

What is the Optimistic view on OCAs?

Answer 18

The optimistic view on OCAs is that intra-industry trade leads to similar specialisation patterns, and integration leads to more equal economic structures and less asymmetric shocks

Question 19

What is the pessimistic view on OCAs?

Answer 19

The pessimistic view on OCAs is that economies of scale lead to agglomeration effects and clustering, and integration actually leads to more asymmetric shocks.

Question 20

Why are divergences of member growth within currency unions problematic?

Answer 20

Divergences in growth rates between nations are problematic because they lead to differing competitiveness between other members, meaning less competitive countries will need to reduce their wage levels relative to rival nations.

Question 21

For every level of expected inflation, what is there a tradeoff between?

Answer 21

For every level of expected inflation, there is a tradeoff between inflation and unemployment

Question 22

What is the difference between a wet and hard nosed government?

Answer 22

A wet government is more focused on reducing unemployment, whereas a hard-nosed government is more concerned with reducing inflation at the cost of unemployment.

Question 23

What do countries that dollarize or euroize hope to achieve?

Answer 23

Countries that dollarize or euroize aim to reduce inflation and it’s effects on their economy by adopting the lower inflation rate of the currency they dollarize with.

Question 24

Why might one central bank be reluctant to join in a union with a second currency?

Answer 24

One central bank might be reluctant to join a union with a second currency due to the fact that the reputation of the other bank is lower than theirs.

Question 25

Why do most of the problems faced by the Eurozone arise?

Answer 25

Most of the problems faced by the eurozone arise because it is not a complete monetary union

Question 26

Completing a monetary union really involves moving towards…?

Answer 26

Completing a monetary union really involves a move towards transferring sovereignty from national the supranational institutions

Question 27

What is a deep variable?

Answer 27

A deep variable is a common sense of belonging and purpose among members of an organisation or state, often called patriotism