Therefore, we argue that the oca theory is a framework for discussion about monetary integration. A the balance of judgements has shifted in favour of monetary union. Lets once again take a not at all hypothetical example. A theory of optimum currency areas1 san francisco state. The theoretical literature on monetary integration has been traditionally dominated by the theory of optimum currency areas oca. Although the basic tenets of the theory were anticipated during the late 1940s and the 1950s, the theory was developed and maturated in three highly influential papers of mundell 1961, mckinnon 1963 and kenen 1969. Optimum currency areas the works of robert mundell. A modern reconsideration of the theory of optimal currency. An optimum currency area oca is a theoretical notion. Abstract this paper surveys the optimum currency area oca literature.
Highinflation countries may find it more difficult to remain in currency unions, as they cannot regain. This pdf is a selection from a published volume from the. Coordination problem often the choice of exchange rate is made as if this is an independent choice. The theory on optimum currency areas has brought some light into the characteristics of areas in which a single currency regime is optimal as mundell 1961 suggests cited in mckinnon, 1996. This article aims at providing an eclectic analysis of the theory of optimum currency areas ocas. The difficulty of the question leads to a low operational precision of oca theory.
Theory of optimum currency area oca is the theoretical basis for analyzing the advantages of membership in a monetary union. 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. So optimum currency area theory was right to assert that creating a single currency would bring significant costs, which in turn meant that europes lack of mitigating factors in the form of high labor mobility andor fiscal integration became a very significant issue. Between the 1980s and early1990s the traditional oca theory was gradually modified in line with new theoretical developments. Following europes decision to move towards emu the theory of optimum currency areas oca, which had remained dormant since the 1970s, was resurrected as a means of analysing the emu project. The theory of optimum currency areas, initiated by robert mundell 1961, is the organizing framework for the analysis. The motivation for this paper arises from the fact that there are many studies that make references to the oca theory, providing various insights for it. European economic and monetary integration, and the. The underlying theory describes the optimal characteristics for the merger of currencies or the creation of a new currency. 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. The theory of optimum currency areas was pioneered by robert mundell in 1961.
Abstractin this article the theory of optimum currency area is applied to postsoviet and other selected countries. European economic and monetary integration, and the optimum. Supply is assumed to be highly elastic, once demand is. This essay follows the synergies and complementarities between european economic and monetary union emu and the optimum currency area oca theory. In the first part of the paper i will address the foundation of this theory through the contributions of mundell 1961, mckinnon 1963.
Although the basic tenets of the theory were anticipated during the late1940s and the 1950s, the. The study finds smaller exchange rate variability when the economies are closely linked by bilateral trade, are subject to similar shocks both on aggregate and at the industry level, have similar inflation rates, are open and smaller in economic size, and have higher labour. Defenders of the common currency and critics as well refer to this theory. A modern reconsideration of the theory of optimal currency areas. Lecturenoteonexchangerateregimes, optimum currency. This analysis has its origins in a debate, during the 1960s, between mundell, mckinnon and kenen about the criteria. Capital market imperfections and the theory of optimum. In formulating the notion of an optimum currency area, mundell appears to have been trying to refute friedman. The theory is used often to argue whether or not a.
Although analyzed in terms of criteria for defining an optimum currency area, we could appreciate that eu fulfils certain criteria established within the theory of the optimum currency area. The economic and monetary union considered, from a certain point of view, the most ambitious and risky. 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 his 1961 article on optimum currency areas, mundell radically reformulated the problem of different exchange rate systems, by posing a new and fundamental question.
Economies form a currency area if they use the same legal tender or have their exchange rates irrevocably fixed. The euro raises issues addressed by a theory known as the optimum currency area oca theory. Lucas critique, endogeneity of the optimum currency area criteria and modern macroeconomic theories. Reconsideration of the theory of optimal currency area. The optimum currency area oca theory tries to answer an almost prohibitively difficult question.
Tavlas is deputy chief of the finance relations division, international monetary fund. Mundell global risk annual lecture as part of the global risk series with his careful analysis of optimum currency area oca theory and its application in the eurozone, professor vitor constancio, former vice president of the european central bank 20102018, pays. The evidence turns out to be strongly supported by the data. Revenge of the optimum currency area the new york times.
But in comparison with usa or canada, the eu has less premises to effectively become such an area. Wh at is emu telling us, ecb working papers, april 2004, no. So that is one main theme of optimum currency area theory. A model if an optimum currency area international monetary fund. The second part considers empirical literature on the types of geographical areas that might constitute optimum currency areas, particularly with respect. A currency thoery based on geographical area that adopts a fixed exchange rate regime or a single currency within its boundaries. Consider a number of countries, and call them a region. Several other important contributions followed suit highlighting a. The author focuses on the main classical contributions, then considers modern treatment of oca theory. A various advancements in economic theory and econometrics have made it possible to progress from the a.
Pdf this article aims at providing an eclectic analysis of the theory of optimum currency areas ocas. Pdf on jan 1, 2014, istvan benczes and others published the theory of optimum currency areas find, read and cite all the research you need on. The evolving optimum currency area theory almost 50 years have passed since the founding of the optimum currency area oca theory thanks to the seminal contributions of, among others, mundell 1961, mckinnon 1963 and kenen 1969. An optimum currency area oca is defined here as the optimal geographic domain of a single currency, or of several currencies, whose exchange rates are irrevocably pegged and might be unified. Fidrmuc, the endogeneity of the optimum currency area criteria, intraindustry trade, and emu. 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. 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. This paper aims to provide a critical analysis of the evolution of the optimum currency area theory.
Grubel australian national university and university of pennsylvania the purpose of this note is to synthesize and extend the existing theory of optimum currency areas. The aim of this paper is to trace how the optimum currency area theory has evolved over time, and use the oca theory as a framework of analysis. More specifically, the paper attempts first to clarify the nature of the institutional changes required for currency area. An oca index for african countries is derived by adapting a method initially proposed by bayoumi and eichengreen 1997.
Capital market imperfections and the theory of optimum currency areas pierrerichard agenor and joshua aizenman nber working paper no. The main credit for developing this analysis, however, goes to mundell 1961 and mckinnon 1963. The optimum currency area theory and the emu intereconomics. In summary, optimum currency area theory suggested two big things to look atlabor mobility and fi scal integration. Mundell published 1961 economics it is patently obvious that periodic balanceofpayments crises will remain an integral feature of the international economic system as long. The theory of an optimum currency area directory of open. Revenge of the optimum currency area nber macroeconomics. The geographic area in which a single currency would create the greatest economic benefit. The optimum currency area oca theory tries to answer an almost prohibitively.
Optimum currency area theory, central banking, transition, european union. The new theory of optimum currency areas tavlas 1993. The optimum currency area theory is a relatively recent area of study. This theory has been described as wondrous doctrine which can often be the background for quite contradictory conclusions d edek, 2002. Of course, the european common currency didnt happen overnight. The single currency, or the pegged currencies, can fluctuate only in. The theory of an optimum currency area indicates some essential elements as preconditions for the successful introduction of a common currency. 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. Mundells 1961 seminal paper a theory of optimum currency areas. Jun 24, 2012 so optimum currency area theory was right to assert that creating a single currency would bring significant costs, which in turn meant that europes lack of mitigating factors in the form of high labor mobility andor fiscal integration became a very significant issue. According to the oca theory, a country that considers membership in a currency union has to balance the. It was the year after the crisis surfaced in what were initially dismissed as a handful of small countries. Conceived during the breton woods system of fixed international exchange.
Several other important contributions followed suit. In mundells paradigm, policymakers balance the saving in transactions costs from the creation of a single money against the consequences of diminished policy autonomy. Exchange rate volatility and optimum currency area. This paper aims at providing an eclectic analysis of the theory of optimum currency areas oca.
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. While traditionally each country has maintained its own separate, national. Inflation is higher for exiting countries but the causality is not clear. Starting in the 1950s, european countries went through various stages of economic and monetary integration.
We turn to that shortly and to the euro in particular. In summary, optimum currency area theory suggested two big things to look atlabor mobility and fi. Martina furrutter 022012 in 1961 robert mundell published his famous article a theory of optimum currency areas1 presenting his idea of an optimal monetary area in which there should be perfect internal mobility of factors and external immobility of factors. The theory of optimum currency areas pioneered by mundell was further complemented by mckinnon and again by kenen.
Pdf a theory of optimum currency areas semantic scholar. In the second half of the 1980s interest in monetary integration was rekindled and the members of the european union faced. In final period of this phase the new theory of optimum currency area began predominating so called the classic theory of optimum currency area. Friedmans influence theory of the optimum currency areas was fully developed during the debates of the benefits and the costs of the particular exchange rates regimes after the world war ii. A national currency however, was considered an axiom. This analysis has its origins in a debate, during the 1960s, between mundell, mckinnon and kenen about the criteria which delineate the optimal domain of a currency area. The theory of optimumcurrencyareas was conceived and developed in three highly influential. Pdf the theory of optimum currency areas researchgate. Although the basic tenets of the theory were anticipated during the late 1940s and the 1950s. Jul, 2009 contributions by mundell 1961, mckinnon 1963, and kenen 1969 laid the foundations for all subsequent work in the area of the theory of optimum currency areas. 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 optimum currency area theory and the euro robert a. The theory of optimum currency areas pioneered by mundell was further. In his work, a theory of optimum currency areas mundell, mundell asserted that there is a balance required in making the determination as to whether or not to share a currency, based upon the costs and benefits involved with the decision and the effects of a monetary union.
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