Session 1

Question 1

Define nominal exchange rate

Answer 1

It is the price of one currency in terms of another

Question 2

What is the real exchange rate?

Answer 2

Price of domestic goods in terms of foreign goods

Question 3

What is a floating nominal exchange rate?

Answer 3

It’s when markets determine the exchange rate.

Question 4

What is a fixed nominal exchange rate?

Answer 4

It is when an exchange rate is fixed administratively or through central bank commitments.

Question 5

What phenomena can affect the real exchange rate?

Answer 5

Nominal exchange rate changes, or because of inflation differential.

Question 6

What’s a currency area?

Answer 6

A geographic domain with a single currency, or several currencies whose exchange rates are irrevocably pegged.

Question 7

What are the advantages of currency unions?

Answer 7

Efficiency of the international allocation of capital (lowers transaction costs and limits exchange rate risk)
Inflation discipline
Currency convenience
Price comparability

Question 8

What’s the Mundell’s trilemma?

Answer 8

It’s a potential drawback of currency unions:

• Monetary independence
• Capital mobility
• Exchange rate stability

Question 9

What are other costs associated with currency unions?

Answer 9

• Loss of one policy instrument
• Risk of free riding
• Competitiveness changes are not offset by exchange rate variation
• Spillovers and contagion

Question 10

On what criterion does the optimality of a currency area depend on?

Answer 10

• Symmetry of macroeconomic shocks
• Flexibility in the labour market and ability to adjust to shocks
• Integration in terms of trade to generate benefits of using single currency
• Fiscal transfers

Question 11

Is the Eurozone an optimal currency area?

Answer 11

No:

• Trade integration yes
• Symmetry is mixed
• No flexibility
• No fiscal transfers

Question 12

What’s the specialisation hypothesis?

Answer 12

It’s the belief according to which as countries become more integrated, they also specialise in te production of goods and services for which they have a comparative advantage. This increases asymmetry and the necessity for country specific policies. Countries may ned to leave the zone, or the Union needs to create a system of transfers that is a centralised fiscal policy.
Litte evidence of it.

Question 13

What is the endogeneity hypothesis?

Answer 13

Maybe ex post, a currency union becomes convenient because the increase in trade increases symmetry and flexibility. So far it is inconclusive.