Common currency

Question 1

Benefits of a single currency

Answer 1

• reduced transaction costs
• less price discrimination between countries (more difficult to hide it)
• eliminates exchange rate fluctuations

Question 2

Costs of a single currency

Answer 2

• a country joining loses its freedom to set monetary policy
• a country cannot make macroeconomic adjustments by changing exchange rates

Question 3

Define asymmetric shock

Answer 3

• suppose there is a shift in consumer demand away from German goods and towards French goods
• AD curves shift asymmetrically (to the right in France and left in Germany)
• this leads to increase unemployment and prices to fall in Germany but the opposite in France

Question 4

Why is asymmetric shock a problem

Answer 4

• German policy makers would want a cut in interest rates to boost AD
• French policy makers would want a rise in interest rates to contain inflation
• ECB cannot manage both simultaneously

Question 5

Define an optimum currency area

Answer 5

A group of countries for which it is optimal to adopt a common currency