Open_Economy_Macro__Lesson_72_

Open_Economy_Macro__Lesson_72_ - Optimal Currency Areas and...

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1 Lesson 72 1 Optimal Currency Areas and the Euro A country that adopts a fixed exchange rate ties its hands with regard to the independent use of monetary policy The ultimate in a fixed exchange rate is when a country abandons its own currency and uses that of another country This lesson explores conditions under which it makes sense for two or more countries to share a common currency Lesson 72 2 Theory due to Robert Mundell (1999 Nobel Laureate in Economics) Benefits of sharing a common currency Easy to compare prices, minimizes transactions costs, minimizes need for duplicative capital equipment (e.g., different coin acceptors in vending machines) But there are significant costs, also Lesson 72 3 Primary cost is loss of independent monetary policy It is “optimal” for two (or more) countries to share a common currency if the benefits of doing so outweigh the costs To fix ideas, think about two countries (call them East and West) that are considering adoption of a common currency
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2 Lesson 72 4 Both countries experience business cycles, with alternating periods of excessive unemployment and excessive inflation Initially, both have different currencies and the exchange rate is flexible, allowing both to conduct successful monetary policy to stabilize their economies
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Open_Economy_Macro__Lesson_72_ - Optimal Currency Areas and...

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