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In a series of influential papers, Martin Feldstein (1993, 1997) argued that the European Monetary Union is an economic liability

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In a series of influential papers, Martin Feldstein (1993, 1997) argued that the European Monetary Union is an economic liability. He agreed that the move to a common currency has some economic advantages, such as lower transaction costs, increased price transparency, and the elimination of nominal exchange rate volatility between EMU members. But he also argued that there are two main economic costs associated with the move into the EMU, and for him, these two economic costs dominate the benefits.

a. (8) What are the two main economic costs for a country that decides to adopt a common currency? Explain your answer.

b. (6) What are the factors that determine whether these costs are large or small? Name two such factors and explain.

c. (6) When the countries in the Exchange Rate Mechanism decided to peg their currencies, they had to deal with two issues: (i) speculative attacks that brought down the Bretton Woods system of fixed exchange rates, and (ii) large variation in inflation rates across the member countries. How did they deal with each challenge?