To what extent does economic and monetary union, represented by the euro, represent an optimal currency area?

An optimal economic area is a geographical region in which it would maximize economic efficiency to have the entire region share a single currency. There are both advantages and disadvantages of being in the euro. The advantages are quite simple, in that no switching of currencies for trade or travel reduces the cost to a minimal point for consumers and firms. However being in the euro also creates problems for some individual countries involved. This is because countries cannot base their interest rates to suit their needs. Instead it is set as a whole currency. The interest will always be set to a maximize the benefits, however there will still be countries that loose out and find the rates set almost impossible to deal with.

Explain what it is meant by economic and monetary union.

An economic and monetary union is an intergovernmental agreement whereby barriers to trade are reduced or eliminated. It is made up of an economic union (common market and free trade area with common external tariffs) and a monetary union (countries that have the same currency).

In what way was the monetary policy too loose for the PIIGS and what were the consequences?

The PIIGS all have the same problem in that they all have a loss in competitiveness compared to the rest of the EU and countries outside the euro area. The monetary policy set by the ECB (European central bank) did not control inflation in all parts of the euro area. The short term growth created from the policy has caused high inflation. this high inflation cannot cause a reduction in the exchange rate as it is fixed with all the other members. This then causes their domestic products to become uncompetitive which will then increase their trade deficit.

Explain the concept of a "loose monetary policy"

A loose monetary policy is one in which tries to increase spending in an economy that is seen to be growing to slowly. The way you do this is by reducing interest rates, which in turn will increase consumer spending as borrowing money is cheaper and more attractive.

Analyse how the problem of uncompetitiveness in the UK economy can be solved by exchange rate adjustment.

Exports and imports are linked to the exchange rate. If there were a strong pound then it would increase the amount the UK would import because they will be cheaper. The reason for this is because other currencies will be seen as weaker so if the UK bought things from other countries the exchange rate would benefit, as the pound can now buy more of their currency. It would then have the opposite effect on exports. If the pound were strong then other countries would buy fewer exports, as they would be lots more expensive for them across the exchange rate to change from one currency to the pound.

If the UK became uncompetitive then it would have to lower its exchange rate because it would mean our exports would become cheaper for other countries. It would also mean that the UK would import less as it would become more expensive for them. This leads to high competitiveness, as the prices of the global market compared to the UK market would become more consistent.

What is it meant by competitiveness and why is a lack of competitiveness seen as a problem?

The term competitiveness is used in describing when two or more firms or economies compete against each other. To have high competitiveness they should all be able to produce their products at roughly the same price including export cost. This means consumers will get a larger range of companies to buy from and lower price as the competition will force the overall price down. So if there were only a few firms in a market there would be a lack of competitiveness so the price of products will not be as low for the consumers as they should be.

If an economy were to become less competitive in a market then this would cause major problems. The first would be increased unemployment, as firms will have to close down, as they can no longer sell their own products because other firms can sell them for much cheaper. It would also mean that there would be deterioration in the Balance of Payments as the economy will import more and export less. This will usually be because there is a decrease in productivity, meaning industry will produce less with higher cost so will become less competitive.