Explain the theory of optimum currency areas. What will be an ...

[Evvie72]

Explain the theory of optimum currency areas.
 
  What will be an ideal response?

Question 2

Explain what the GG-LL model tells us about the benefits of extensive trade between EU member states and comment on the significance of similarity of economic structure in this framework.
 
  What will be an ideal response?

[trampas]

Answer to Question 1

The theory implies that countries will wish to join fixed exchange rate areas closely linked to their own economies through trade and factor mobility. This decision to join is, in turn, determined by the difference between the monetary efficiency gain from joining and the economic stability loss from joining. These factors are both related to the degree of economic integration between the joining country and the larger fixed exchange rate zone. Only when economic integration passes a critical level is it beneficial to join.

Answer to Question 2

The GG-LL model shows that extensive trade with the rest of the euro zone makes it easier for a member to adjust to output market disturbances that affect it and its currency partners differently. A key element in minimizing such disturbances is similarity in economic structure, especially in the types of products produced. Euro zone countries are, in fact, not entirely dissimilar in the manufacturing structure, as evidenced by the very high volume of intraindustry trade. The hope is that any difference in EU member country factor endowments will be minimized by the completion of a single European market and the redistribution of capital and labor across Europe. This will bring about the desired similarity of economic structure.