The recent comparative calm in financial markets has done nothing to change this fundamental reality. The eastern caribbean currency area ecca and the cfa zone in africa are intermediate between the two types of unions. The second part applies the listed factors to the eurozone in order to determine whether or not a specific criterion is fulfilled by the european emu. An optimum currency area is an economic unit composed of regions affected symmetrically by disturbances and between which labor and other factors of production flow freely. An optimum currency area oca is a geographical region in which maximise economic efficiency is attained by the entire region sharing a single currency a monetary union, or by several currencies pegging to each other via a fixed exchange rate. In the first part of this assignment the main contributors to the theory of optimal currency areas are enumerated and its most significant factors are explained. The traditional optimal currency area approach draws its insig hts largely f rom an economic environment in which there e xists. Optimum currency areas under what conditions would a group of countries like to operate under a single currency regime mundell first posed and answered this question in the early 1960s a common currency, greatly reduces the cost of cross border economic transactions and fosters competition as prices in. Countries within it are highly integrated with each other i. An optimum currency area oca is a theoretical notion. The main idea was to define until what extent some countries ez countries, for instance should give up from their independent monetary policy, in order to gain from micro and macroeconomics.
An optimal currency area oca is a geographical region where it is thought a single currency would help to maximise welfare and enhance macroeconomic performance. In both cases, the countries have a joint currency and a joint central bank. Price and wage flexibility low, labor mobility low, degree of econ openess good, diversification in production and consumption good, similiarities of inflation rates soso, financial market integration soso, fiscal integration nonexistant, political integration very low. Some may argue that the european monetary union is, in practice, a german mark area, but this interpretation is questionable. Optimum currency areas, exchange rate regimes, optimality criteria. A suggested reformulation of the theory of optimal.
Optimal currency areas martin feldstein pdf version i am very pleased to be a participant in this ecb central bank conference on the tenth anniversary of the creation of the euro and of the european economic and monetary union emu. While it is difficult to specify the conditions for an optimal currency area, it is clear that the eurozone. The optimum currency area approach to european monetary integr. Jun 24, 2012 unfortunately, it turned out that optimum currency area theory was essentially right, erring only in understating the problems with a shared currency. However, we have not observed a tendency in this direction. This chapter discusses the theory of optimum currency area. May 07, 2015 however as was in 1950, an optimum currency area as defined above is still a very ambiguous region even with todays developments of the theory referencing the practicality of european monetary union emu. The theory of optimumcurrencyareas was conceived and developed in three highly. Pdf this article aims at providing an eclectic analysis of the theory of optimum. In economics, an optimum currency area oca, also known as an optimal currency region ocr, is a geographical region in which it would maximize economic efficiency to have the entire region share a single currency the underlying theory describes the optimal characteristics for the merger of currencies or the creation of a new currency. Stefan collignon with respect to european monetary union emu the question of sustainability is quite simple. Kehoe federal reserve bank of minneapolis and university of minnesota abstract the classic optimal currency area criterion is that countries with more correlated shocks are better.
This paper will outline the advances in oca theory, highlight the bene. It is a great satisfaction to be the recipient of so much kindness occasioned by my 1961 article on optimum currency areas. The theory is used often to argue whether or not a. An economics theory credited to robert mundell in which economic efficiency would be maximized in a geographical region if the region all shared a single currency. Supply is assumed to be highly elastic, once demand is. Oca is a geographic area that is best suited to share the same currency because it would optimize the regions economic efficiency. The purpose of this note is to synthesize and extend the existing theory of optimum currency areas. I proceed first with a brief historical background of monetary and economic arrangements in africa in the post independence period. Putting the gg and ll schedules together the intersection of gg and ll determines a critical level of economic integration between a fixed exchange rate area and a country shows how a country should decide whether to fix its currencys exchange rate against the euro the theory of optimum. Although the basic tenets of the theory were anticipated during the late1940s and the 1950s, the. Much of the economic analysis of moving to emu has been undertaken within the context of the optimal currency area paradigm. Oca theory, especially costs and benefits stemming from joining monetary union. The underlying theory describes the optimal characteristics for the merger of currencies or the creation of a new currency. This is the spatialgeographic counterpart of the currently dominating model of the nature and evolution of money, here termed m theory, whereby money is viewed as having developed from a private sector cost minimisation process to facilitate trading.
The optimum currency area oca theory tries to answer an almost prohibitively difficult. Chari university of minnesota and federal reserve bank of minneapolis alessandro dovis penn state and princeton ies patrick j. Jan 06, 2012 for all those interested in optimum currency areas my new infoposter economics is now available. The symmetrical nature of disturbances and the high degree of factor mobility make it optimal to forsake nominal exchange rate changes as an instrument of adjustment and to. Optimum currency areas under what conditions would a group of countries like to operate under a single currency regime mundell first posed and answered this question in the early 1960s a common currency, greatly reduces the cost of cross border economic transactions and fosters competition as. R 1 beware of europhoria, the economist, may 10, 2014. Optimum currency area, a currency area in which the benefits of using a common currency outweigh the costs of individual economies giving up their own currencies. Therefore, we argue that the oca theory is a framework for discussion about monetary integration. The optimum currency area approach to european monetary. A modern reconsideration of the theory of optimal currency. In final period of this phase the new theory of optimum currency area began predominating so called the classic.
Mundells analysis was shortly afterwards elaborated on by mckinnon 1963, and by kenen 1969, since when optimum currency area oca theory was developed by a growing number of studies, both theoretical and empirical. On the contrary, for inflationprone countries joining a monetary union only leads. European monetary union, convergence and sustainability. We also address the question of how trade and comovements of outputs and prices would respond to the formation of a currency union. I also thank the participants in the conferences monetary policy implications of heterogeneity in a currency area, organized by the european central bank in 2004, 40 anni di attivita dellente einaudi 19652005 organized by ente. Martina furrutter 022012 which exchange rates are fixed o2, he was the first to question the appropriate domain of a currency area, however. The difficulty of the question leads to a low operational precision of oca theory. Chapter 20 optimum currency areas and the european. In final period of this phase the new theory of optimum currency area began predominating so called the classic theory of optimum currency area. As far as the treaty on european union is concerned, the single currency will be forever. The endogenity of the optimum currency area criteria pdf. The eurozone crisis has revealed certain shortcomings of the emu, such as its vulnerability to asymmetric shocks and its inability to act as predicted by the theory of optimum currency areas.
An optimal currency area oca is a domain within which exchange rates are. The case for separate currency areas clearly holds good only if the impact of a shock varies between areas. The optimum currency area oca theory tries to answer an almost prohibitively difficult question. For him the optimum currency area is the region and not the nation, and he strikes the vital importance of a. Reconsideration of the theory of optimal currency area. Indeed, it is these economiesofscale factors that led to the emergence of one or two precious metals as the base of historical international monetary systems. While traditionally each country has maintained its own separate, national. Pdf is optimum currency area theory irrelevant for. The optimum currency area oca theory tries to answer an almost. Abstract this paper surveys the optimum currency area oca literature. The traditional optimal currency area approach draws its insights largely from an economic environment in which there exists shortrun price stickiness and employment adjustment to shocks, accompanied by a longerrun inflationemployment tradeoff. Ifierpapers combine theoretical reasoning and academic discussion of cur rent research subjects in the two. Although the share of intraeu trade has increased since the introduction of the euro, dissimilarities in economic structure combined with high degrees of industrial specialisation have increased the emu.
The optimum currency area theory and the emu intereconomics. More specifically, the paper attempts first to clarify the nature of the institutional changes required for currency area formation and second, to spell out the functional relationships between welfare and currency area formation. The optimal order in which new members are admitted to the union then becomes a central aspect of the problem. A suggested reformulation of the theory of optimal currency areas. Bofit discussion papers editorinchief iikka korhonen bofit discussion papers 152003 25. From the standpoint of these factors, the optimum currency area is the world. Download 7page essay on economics optimal currency area 2020.
The geographic area in which a single currency would create the greatest economic benefit. Optimal currency area criteria price and wage flexibility low, labor mobility low, degree of econ openess good, diversification in production and consumption good, similiarities of inflation rates soso, financial market integration soso, fiscal integration nonexistant, political integration very low. Unfortunately, conventional optimal currency area theory is quite deficient. This paper aims at providing an eclectic analysis of the theory of optimum currency areas oca. In principle, an optimal currency area could also be smaller than a country, that is, more than one currency could circulate within a country.
Revenge of the optimum currency area the new york times. The more countries that join a currency area, the more efficient it will be. Mundell it is patently obvious that periodic balanceofpayments crises will remain an integral feature of the international economic system as long as fixed exchange rates and rigid wage and price levels prevent the international price system from fulfilling a natural role in the adjustment process. Empirical explorations of the krugman 1993 hypothesis that monetary integration leads to more regional specialisation have been inconclusive.
A currency thoery based on geographical area that adopts a fixed exchange rate regime or a single currency within its boundaries. Mar 30, 2017 a look at the economic preconditions and political backstops required for a successful oca. This contributed to creation the new theory of optimum currency area and arising of debate on sizes of currency area and deadline of the currency area creation tavlas 1993. Along with other advantages, this approach makes it easier to defend the argument that many nations are too small for form optimal currency areas. A modern reconsideration of the theory of optimal currency areas. A theory of optimum currency areas san francisco state. In economics, an optimum currency area oca, also known as an optimal currency region ocr, is a geographical region in which it would maximize economic efficiency to have the entire region share a single currency. The underlying theory describes the optimal characteristics for the merger of. Economies form a currency area if they use the same legal tender or have their exchange rates irrevocably fixed. Bank of finland, institute for economies in transition bofit discussion papers 152003 3. Pdf the theory of optimum currency areas researchgate. Keywords optimum currency area theory, european monetary union, emu.
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