TOPIC 3.2 Single Currencies

Question 1

What are the two types of single currencies?

Answer 1

1. When countries adopt another countries currency (dollarization)
2. When countries create a new currency (e.g. Euro)

Question 2

What is dollarization?

Answer 2

Where a country holds and uses another currency as a medium of exchange, store of value, and unit of account, alongside or instead of the local currency.

Question 3

What is unofficial dollarization?

Answer 3

Holding foreign assets

Not legal tender

Question 4

What is Semi-Official Dollarization?

Answer 4

Legal tender

Used as a secondary currency alongside domestic currency.

Question 5

What is Official Dollarization?

Answer 5

Exclusive status as full legal tender
Domestic currency (if still existing) plays a secondary role.

Question 6

What does official dollarization offer?

Answer 6

Lower transactions costs
Part of a large and liquid international pool of funds
Lower inflation now and in the future
Fiscal and monetary discipline

Question 7

What are the costs of official dollarization?

Answer 7

Loss of Seignorage = profit from making money (e.g. print $100 for 10c = profit of $99.90)
One off conversion costs (vending machines)
Cost of losing a domestic CB as a lender of last resort.
Cost of loosing flexibility in monetary policy (business cycles)

Question 8

What is a single currency Area?

Answer 8

Area where ER are fixed within the area due to members sharing the same currency and floating ER exist against currencies outside the area.

Question 9

What is a Optimum Currency Area?

Answer 9

Best grouping of countries that share the same currency, to achieve some objective, such as ease of adjustment to real or nominal shocks. Not all single currency areas are optimum.

Question 10

What is the optimum currency areas criteria?

Answer 10

High degree of trade between countries
Relatively similar business cycles
High degree of labour and capital mobility between regions
Large fiscal transfers between regions.

Question 11

Does Argentina meet OCA criteria?

Answer 11

No.

Because…

1. US is second most important trading partner but trade to US is < 15% of total trade. Therefore not sufficient.
2. Argentina GDP: little correlation with US GDP, while US was expanding they were receding thus GDP negatively correlated. Not sufficient.
3. NO labour and Capital mobility between Argentina and the US. Not sufficient.
4. No fiscal transfers between Argentina and the US. Not sufficient.

Question 12

Example of criteria in optimum currency area?

Answer 12

Once a group shares a currency then their business cycles will sync
Therefore you need flexible L and K
Because a expanding economy can invest into recessionary economy.