Question

There are two questions related to Regional Trading Arrangements 1.Explain the theory of optimum currency areas. 2.Concerning transition economies, what do the advocates of shock therapy propose?

Answer 1

Answer)

Much of the analysis of the benefits and costs of Europe's common currency is based on the theory of an optimum currency area. According to this theory, the gains to be had from sharing a currency across countries' boundaries include more uniform prices; lower transaction costs, greater certainty for investors, and enhanced competition. These gains must be compared against the loss of an independent monetary policy and the option of changing the exchange rate.

Advocates of shock therapy maintain that economies in transition should proceed immediately on all fronts. That is, they should privatize, abandon price controls, liberalize trade, and develop market institutions, and so on as quickly as possible. Although the initial economic pain may be severe, it will subside as the transition to the market economy leads to rising living standards.