Question

a.What is a Currency Board, and why is it often recommended for small countries?

b. What are the conditions for an Optimal Currency Area? Does Europe meet these conditions? Why must monetary policy for the Euro area be conducted by a single European Central Bank, rather than allowing the individual central banks in each member country the right to issue Euros in place of their own currency?

Answer 1

a)What is a Currency Board?

A currency board is a monetary authority that is required to maintain a predetermined exchange rate with a foreign currency. This policy requires the objectives of a central bank to be assisted in the exchange rate target.

Why is it often recommended for small countries?

Because Small countries find it more reasonable to keep a high level of reserves relative to the money supply than do large countries, Meeting enough re-serves to launch a currency board is also less likely to experience a major problem.

b)What are the conditions for an Optimal Currency Area?

There are mainly four criteria for an optimum currency area as theory states :

1. A large, available, and integrated labor market in which makes workers move freely throughout the area and smooth out unemployment in any single zone.
2. The flexibility of pricing and wages, along with the mobility of capital, to eliminate regional trade imbalances.
3. A centralized budget or control to redistribute wealth to parts of the area which suffer due to labor and capital mobility, Were wealthy parts of the region may not wish to distribute their surpluses to those that are lacking results lightens a politically difficult one.
4. The participating regions have similar business cycles and timing for economic data to avoid a shock in any one area.

Does Europe meet these conditions?

OCA theory has been most frequently applied to discussions of the euro and the European Union. There were several argues that the EU did not meet the criteria for an OCA at the time the euro was adopted, and attribute the Eurozone's economic difficulties in part to continued failure to do so. Europe shows some indicators shows measures characterizing an OCA. By looking at the correlation of a region's GDP growth rate with that of the entire zone, As compared to the U.S. states the Eurozone countries show better correlations. However, it has lower labor mobility than the United States, possibly due to language and cultural differences. In the European Union countries, Less than 20% of people were born in a different country than the one in which they live.

Why must monetary policy for the Euro area be conducted by a single European Central Bank, rather than allowing the individual central banks in each member country the right to issue Euros in place of their currency?

Monetary policy involves influencing interest rates and exchange rates to benefit a country’s economy. This is done by a central bank controlling the supply of money in the economy. However, if each EU country operated its monetary policy, then A) The single market would be incompetent   B)Trade could be disturbed    C)The benefits would be hardly any.

For this reason, the European Union's monetary policy is closely coordinated, and within the euro area, it is centralized and independent.