The Puzzle of Joining a Monetary Union Despite its Disadvantages

Two small, open economies, Country A and Country B, are identical except for their monetary policy frameworks. Country A is part of a large monetary union with a shared currency. Country B has its own currency, a flexible exchange rate, and an independent central bank. Both countries experience a sudden and persistent collapse in global demand for their main export good. Which statement best analyzes the likely economic adjustment process in the two countries?

Comparing Economic Adjustment Mechanisms

Contrasting Real Exchange Rate Adjustment Speeds

Comparing Adjustment Speeds to an Economic Shock

An economy that is part of a large monetary union experiences a persistent negative shock to its export demand. Compared to an otherwise identical economy with a flexible exchange rate and its own monetary policy, what is the primary obstacle the first economy faces in restoring its external competitiveness?

Comparing Adjustment Paths to a Positive Shock

A small country within a large monetary union experiences a sudden, persistent boom in its tourism sector, leading to a positive shock to its aggregate demand. Arrange the following economic events in the logical sequence that describes the slow, automatic adjustment process that will eventually return the economy to equilibrium.

Match each economic adjustment characteristic to the corresponding monetary policy regime.

In response to a persistent positive country-specific demand shock, an economy with its own currency and independent monetary policy will experience a more rapid appreciation of its real exchange rate than an otherwise identical economy within a monetary union, primarily because the former can use its policy interest rate to influence the nominal exchange rate.

Two small, open economies, Eastland and Westland, are identical in every way except for their monetary arrangements. Eastland is a member of a large currency union, while Westland has its own currency and an independent central bank. Both countries experience a sudden, large, and permanent increase in foreign demand for their exports. Which statement correctly analyzes the primary reason for the difference in the speed at which each country's real exchange rate will appreciate to restore equilibrium?