Economics Optimal Currency Area an Essay

  • Length: 7 pages
  • Sources: 10
  • Subject: Economics
  • Type: Essay
  • Paper: #50405286

Excerpt from Essay :

Thus, a region or nation experiencing economic depression will be unable to use the interest rate lever to boost the economy. Similarly a country with high inflation will be unable to independently raise interest rates to contain inflation. Moreover, Islamic countries, which form a large part of the geography, do not believe in interest rates.

Political barriers -- Political differences between nations make it extremely difficult for them to adopt a common currency. It can lead to a loss in political sovereignty as monetary interests would need to surpass political interests. This is unlikely to be acceptable to most of the nations and the idea of a single currency may be difficult to implement (Gimp, 2008).

Will Pros and Cons change Over Time? Depending On the Country?

The economic conditions to determine a monetary union depend on: the openness and size of the economy involved to trade; the free movements of capital and labor factors; the high level of intra-regional trade and the diversity of production; and the susceptibility of the economy to asymmetric shocks and the flexibility of the economy to adjust itself to such shocks. In other words, the introduction of a single currency in a specific region depends on what kind of integrated regional market it is (Filho, 2003).

In general, the analysis of OCA shows that fixed exchange rates are more appropriate for countries which are completely integrated. In this context, a country's decision to join a currency area is determined by the weight of the advantages and disadvantages of having (or

not) fiscal and monetary policies centralized to promote economic integration and co-operation policy.

Under these circumstances, what are the advantages and disadvantages to a specific country when it decides to join a monetary union, according to the theory of OCA? The

economic benefits from monetary union are related to the microeconomic efficiency, such as:

the inflation rate in the monetary union would be significantly lowest; the transaction costs

and hedging costs of economic agents related with the risks of exchange rate changes would decrease or be eliminated; the purchasing power parity of the country would be stable; the elimination of the board taxes would standardize the products of the economy; the exchange control barriers to factor mobility would be removed; and regional integration would be stimulated (Filho, 2003).

On the other hand, the main reason a country might avoid joining the monetary union is the following: the country prefers to operate its independent economic policy for promoting economic growth, payments balance and full employment having the exchange rate as an instrument of economic policy.

To summarize the main idea presented above, the discussion shows that, before deciding to enter (or not) a monetary union, countries have to analyze the pros and cons of economic policy consequences. In other words, a country's decision to join a monetary union creates the following trade-off: microeconomic gains resulting from co-ordination policy vis-avis macroeconomic loss as a consequence of not operating independent monetary and fiscal policies.

(Filho, 2003)


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