Question

What is meant by an optimal currency area? How does this relate to the formation of a monetary union?

Answer 1

An optimal currency area is the geographical area in which sharing a single currency will create greatest economic benefits to the entire region.

Monetary union is formed on the basis of both economic and political consideration of two or more states within a geographic region, where they create a single currency area. A monetary union is accompanied by setting up a single monetary policy and establishing a common central banking system. For these states, their respective national currencies become denomination of an invisible common currency. From an economic point of view, monetary union helps reducing transaction costs in an increasingly integrated regional market and benefits the entire region.