Title: Navigating the Complexity: Optimal Currency Area Literature Review

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Currency Areas (OCAs), this complexity is amplified. Understanding the nuances, historical
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which involves examining factors such as economic integration, exchange rate regimes, monetary
policy coordination, and asymmetrical shocks, adds layers of intricacy to the review process.

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of perspectives, methodologies, and empirical findings. Each contribution to the literature brings its
own unique insights, hypotheses, and critiques, contributing to the rich tapestry of knowledge
surrounding OCAs.

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In this sense, these twin coun- tries together constitute an optimum currency area 2. 4. Results and
Analyses We reconsider the theory of optimum currency area from the perspective of resource
allocation and income distri- bution. So far, we have only looked at the costs of forming a monetary
union. And as a silver lining, maybe the current crisis is a godsend for integrationists to push through
some of the institutional reforms required to increase the political integration dimension to the EMU.
Does that mean India is not ready to be an OCA and therefore states should have their own
currencies. Changes in GDP can also be measured both in relation to separate currency areas and to
some extent within them, where comparable national or regional statistics are available. In other
words, business cycles have differing impacts across the euro area, which lacks the necessary fiscal
institutions to cushion the blow in places hit relatively hard. Greg Mankiw posted that an OCA
required not just a strong fiscal authority, but also a different set of labor institutions, one that
facilitates faster adjustment of wages. I am inclined to the view that construction of an OCA is in
large measure about effective fiscal federalism. Mechanisms were therefore required to adjust
relative prices between east and west rather than between north and south. If funding from the EU
budget is merely used to substitute for national expenditure which would have taken place anyway,
the effect will be more cyclical than structural. Critique of OCA-theory can be formulated at three
different levels: How relevant are the differences between countries. See also this analysis of the
Euromess by Krugman, with the illustrative case of Spain, about the importance of fiscal and labor
market integration before a currency union. This involves permanently fixing exchange rates among
the member countries, co-ordinating monetary and fiscal policies, instituting a regional policy for
depressed area within the EEC and finally establishing a common currency. Secondly, certain
benefits expected from an optimum currency area can be obtained even through fixed exchange
rates. He also suggests that the US economy itself, with its North-South labor mobility restrictions
till after the War, did not become acquire characteristics of an OCA until the 1930s. Should currency
area borders coincide with national borders. Researchers who have examined the economic
advantages and disadvantages of EMU have adopted the idea of an optimum currency area as an
obvious starting point. Self-motivation to interact and collaborate using: emergent requirements
social relationships. June 24, 2012. The advantages of a common currency. A few questions. Would it
be desirable for the whole world to have one currency. However, some argue that the area did not
meet the four criteria as laid out by Mundell’s theory at the time of the euro's creation in 1999. The
statistical data may not be comparable for different areas - even the best efforts of Eurostat were not
able to make the harmonised index of inflation inclusive of all consumer prices in time for the EMU
evaluation in March 1998. Introduction. This chapter focuses on the following questions. How the
European Single Currency Evolved The Euro and Economic Policy in the Euro Zone The Theory of
Optimum Currency Areas. How the European Single Currency Evolved The Euro and Economic
Policy in the Euro Zone The Theory of Optimum Currency Areas. A number of the peripheral
economies of EMU falls well inside the OCA boundary. To Accompany International Economics:
Theory and Policy, Sixth Edition by Paul R. It is clear that the nation is not an opti- mum currency
area. Optimum Currency Areas and the European Experience. More specifically, he calls for labor
mobility across borders and wage flexibility.
If the two regions each had their own currency, the disequilibrium could be resolved by a
depreciation or devaluation of the exchange rate of region A relative to region B. Because of the
symmetry of the countries, the optimal coordination policy is also symmetric. Thus, a serious income
disparity and a large decrease in social welfare occur. It is probably for this reason that a number of
recent studies have defined asymmetry on the basis of differential employment effects. The Mundell
model. Assumptions two countries full employment BP in equilibrium short term price and wage
rigidity. Since the outcomes of the first stage are summarized by (10), taking the social welfare (8)
and the equilibrium condition for each aggregated goods market (9) into consideration, the best
response of each central bank is to maintain the full-employment equilibrium, which is defined as the
amount of real capi- tal that is associated with its country. When an economic region is hit by a
negative economic shock, the centralized union budget will automatically transfer income from
member states experiencing better economic conditions, and therefore paying a greater amount into
the union budget, to member states experiencing worse economic conditions who receive
unemployment insurance from the union budget. How the European Single Currency Evolved The
Euro and Economic Policy in the Euro Zone The Theory of Optimum Currency Areas The Future of
EMU. The American Economic Review. Vol. 51, No. 4. Pg. 657-665. September, 1961. The varying
rates of inflation may involve them into BOP disequilibria which will require adjustments in
exchange rates. The variable interest rate liabilities of the UK personal sector total 64% of GDP.
Each central bank is led to adopt an artificia l high interest pol- icy because more capital induced by
a rate slightly higher than the rates of its rival central bank brings about higher incomes for the
business skills possessed by the residents of that central bank’s nation. A Holistic Modular Design
Methodology Supporting Multiple Views of the Product Development Process. Whatever the end
result of the ongoing crisis, I cannot but argue that the benefits of a single currency, by way of
lowering of business transaction costs and tariff barriers, and the consequent increase in trade, are
too large to be overlooked. Advanced economies also f ace this growing problem. That is, the small
twin countries constitute an optimum currency area whenever the real capital mobil- ity is complete.
Yes, they have access to fiscal transfers, labor mobility is great, culturally they are similar, and
politically there is will for the dollar union. A number of the peripheral economies of EMU falls well
inside the OCA boundary. The minimum perimeter for a rectangular shape for a given area is a
square. Several weaknesses of the analytical framework of the early OCA theory have now been
amended. Higher is the ratio of traded to non-traded goods or higher the ratio of foreign trade to
GNP, more beneficial it is to form a currency area. The second concerns the glut of foreign direct
invest- ment. Since, as seen in (8), the social welfare of residents is proportional to their income, the
deepening income disparity also results in a less effi- cient economy. It is clear that the nation is not
an opti- mum currency area. It may be more practical to place a levy on international capital
movement, like the Tobin tax. Mohammad Reza Asadi, MSc; Giti Torkaman, PhD; Mehdi Hedayati,
PhD; Mahmood Mofid, MSc. Aim. Share to Twitter Share to Facebook Share to Pinterest.
Introduction of European Union. 1970’s, Collapse of the Bretton Woods System The European
Economic Community (EEC) (Germany, Italy, France Netherlands, Belgium and Luxembourg)
European Union. Critique of OCA-theory can be formulated at three different levels: How relevant
are the differences between countries. Note that the extent of both of these benefits grows as the
degree of openness between the economic regions increases (i.e. the more trade the economic regions
conduct with each other, the greater the reduction in transaction costs and the more significant the
effect of reduced exchange rate uncertainty).
Introduction of European Union. 1970’s, Collapse of the Bretton Woods System The European
Economic Community (EEC) (Germany, Italy, France Netherlands, Belgium and Luxembourg)
European Union. The benefits come from reduced transactions costs and reduced uncertainty about
exchange rates. The first is the difficulty of central bank unification. Real capital is allocated equally
by abolishing the competitive and artificial high-interest pol- icy. He began piano lessons at seven,
and studied Latin and Greek in school in Zwickau, he then began playing piano and writing novels.
This would, in turn, help to determine whether the optimum currency area in the European Union is
still in existence today and whether it has potential to expand and generate benefits for its future
members. The effects of this asymmetric shock are represented in the figure below. And the
appreciation of region B’s currency will alleviate the inflationary pressures in region B by increasing
the cost of region B’s economic good for consumers in region A, thereby reducing demand for region
B’s good. So the optimum currency area should include such countries in which the propensities to
inflation are similar. Assume that region A produces a single economic good and region B produces a
different economic good. Country A would then recover its competitive position through lower real
wages and prices (though nominal wages and prices would remain constant). In this sense, we
propose the unification of central banks. Critique of OCA-theory can be formulated at three different
levels: How relevant are the differences between countries. Such competition is described by the
following two-stage game. According to the theory, a common currency can maximize economic
efficiency, provided that the participants meet the following four criteria. We concentrate on the case
of twin countries under per- fect capital mobility and immobile labor forces. Introduction. This
chapter focuses on the following questions. Yet the point is of considerable significance in the light
of the empirical evidence which has been collected in relation to the creation of EMU. Benefits and
Costs involved in adopting a common currency. To Accompany International Economics: Theory and
Policy, Sixth Edition by Paul R. Second, given the volume of capital deployed and goods produced,
the residents and owners mutually determine the income dis- tribution in accordance with the
asymmetric Nash bar- gaining solution. However, because of internal conflicts and contradictions, the
theory gathered gloom for the next two decades before it could make a solid comeback in the early
1990s. The unification of two central banks is desirable for overcoming such a difficulty. A closed
economy, on the other hand, should rely upon exchange rate changes rather than monetary and fiscal
policies to realize the goal of internal and external stability. To Accompany International Economics:
Theory and Policy, Sixth Edition by Paul R. A fixed relationship has often been assumed between
changes in GDP and changes in the rate of unemployment. It has nevertheless indicated that
membership is likely in the early years of the next century. In other words, business cycles have
differing impacts across the euro area, which lacks the necessary fiscal institutions to cushion the
blow in places hit relatively hard. All participants were invited to take part in the dietary survey.
Demand would rise (D upshift) and unemployment fall. However, the fierce competition between
the central banks ultimately exacerbates the disparity in income distribution. Benefits and Costs
involved in adopting a common currency. In this sense, we propose the unification of central banks.
His letters open and close the novel.. In his letters he tells his stories all addressed to his sister
Margaret Saville who resides in England.. Robert Walton. Optimum Currency Areas and the
European Experience. Student: Cosma Anita Georgiana Supervisor: Professor Mois a Altar. So the
optimum currency area should include such countries in which the propensities to inflation are
similar. Thus, we obtain and It is evident that th e social welfare of each country (8) becomes 1 AB
mm ?? 0. See also this analysis of the Euromess by Krugman, with the illustrative case of Spain,
about the importance of fiscal and labor market integration before a currency union. Mohammad
Reza Asadi, MSc; Giti Torkaman, PhD; Mehdi Hedayati, PhD; Mahmood Mofid, MSc. Aim. Should
currency area borders coincide with national borders. Recent advancements in the area using
dynamic general equilibrium analysis shows that the revival of interest in the theory of OCA reflects
developments in a literature that has little to do with the subject of OCAs itself. Higher is the ratio
of traded to non-traded goods or higher the ratio of foreign trade to GNP, more beneficial it is to
form a currency area. As long as two central banks extend the non-coop- erative game to attract more
capital, the inco me disparity deepens against their intentions. An optimum currency area could be
several nations, parts of several nations, or regions inside a single nation. Reduced transaction costs E
limination of currency risk G reater transparency and possibly greater competition because prices are
easier to compare. The statistical data may not be comparable for different areas - even the best
efforts of Eurostat were not able to make the harmonised index of inflation inclusive of all consumer
prices in time for the EMU evaluation in March 1998. This would reduce the price of region A’s good
for consumers in region B, thus increasing demand for region A’s good, and so, alleviating region A’s
unemployment (see figure 5). To turn the European Union into a truly unified market. OCA theory
indeed implies that any two countries generally experiencing symmetric shocks, and trading
significant proportions of their GDP bilaterally, should fix their exchange rates. Capital income is also
earned when the owner is young, and then capital itself is passed to a descendant. Miss Joanne Smith
Final Year PhD Student Supervisor: Dr Alex Duffy. More specifically, he calls for labor mobility
across borders and wage flexibility. Introduction of European Union. 1970’s, Collapse of the Bretton
Woods System The European Economic Community (EEC) (Germany, Italy, France Netherlands,
Belgium and Luxembourg) European Union. It has nevertheless indicated that membership is likely
in the early years of the next century. AI More Topics Corporate Finance Investing Taxes Regulations
Insurance Accounting Banking. June 24, 2012. The advantages of a common currency. Differences
due to culture, ethnicity, tradi- tion, and etc., are not as easy to overcome as our theory assumes. The
implication is that the loss by EU Member States of the ability to alter exchange and interest rates is
likely to have only minimal consequences for the handling of the actual shocks that are experienced.
Acknowledgments to non Supervisors: Walter Hamscher, Charles Hoffman, Ignacio Hernadez-Ros,
Eduardo Carrillo, Allyson Ugarte, Colm O hAonghusa. In response to financial shocks the exchange
rate should be kept constant and the shift in the portfolio composition should be satisfied by varying
the supply of assets denominated in specific currencies. Furthermore, for sim- plicity, a unit real
capital combined with a resident’s business skills produces a unit good. Higher is the ratio of traded
to non-traded goods or higher the ratio of foreign trade to GNP, more beneficial it is to form a
currency area. The following theorem holds concerning the unique- ness of the Nash equilibrium:
Theorem 1. Shocks of the second kind, however, can in general only be met by a decline in
comparative real incomes and prices; by labour force migration; or by major long-term restructuring.
If funding from the EU budget is merely used to substitute for national expenditure which would
have taken place anyway, the effect will be more cyclical than structural. The statistical data may not
be comparable for different areas - even the best efforts of Eurostat were not able to make the
harmonised index of inflation inclusive of all consumer prices in time for the EMU evaluation in
March 1998. How the European Single Currency Evolved The Euro and Economic Policy in the
Euro Zone The Theory of Optimum Currency Areas. More particularly, treating shocks with a
permanent, structural effect as if they were temporary may only serve to entrench the underlying
loss of competitivity and make necessary reform more difficult. We find that the thrust of the
pioneering contributions is still relevant and we still discuss all OCA properties. In the first stage,
central banks determine (,) AB. Recent advancements in the area using dynamic general equilibrium
analysis shows that the revival of interest in the theory of OCA reflects developments in a literature
that has little to do with the subject of OCAs itself. A number of the peripheral economies of EMU
falls well inside the OCA boundary. Bureaucrats who operate the unified central bank may be of
different nationalities. In sum, the OCA theory amounts to a cost-benefit analysis for monetary
unions. The merit of the OCA theory is that it helps to bring together several strands of the literature
on monetary integration. The Mundell model. Assumptions two countries full employment BP in
equilibrium short term price and wage rigidity. This would reduce the price of region A’s good for
consumers in region B, thus increasing demand for region A’s good, and so, alleviating region A’s
unemployment (see figure 5). Reduced transaction costs E limination of currency risk G reater
transparency and possibly greater competition because prices are easier to compare. Treatment of
poor responders has been attempted with various methods in retrospective, prospective, studies using
comparative and non-comparative designs. The pioneering work in this field was done by J.E. Meade
and T. Scitovsky in 1957-58. Country A would then recover its competitive position through lower
real wages and prices (though nominal wages and prices would remain constant). Please check your
email and confirm it to read insightful articles, videos and download free eBooks. It is also
noteworthy that our approach is based on a rigorous dynamic microeconomic foundation, and thus,
enables the economic welfare analy- sis. Please try again. Email Address Id like to receive the free
email course. Fluorescence: One phenomenon, many applications Jussi Kinnunen, MSc (Physics),
PhD student. Costs and benefits of currency union are measured along the vertical scale. A few
questions. Would it be desirable for the whole world to have one currency. This as- sumption seems
natural if we consider the significance of the existence of nation states.
Just enough external money is supplied to ensure the full-employment equilibrium in each country.
Fluorescence: One phenomenon, many applications Jussi Kinnunen, MSc (Physics), PhD student. The
maximum area for a rectangular shape for a given perimeter is a square. Costs and benefits of
currency union are measured along the vertical scale. September 1998. A member of the Sub-
Committee, Professor Katiforis, posed the question: given that Member States within EMU will no
longer have an independent monetary policy, and will be limited by the Stability and Growth Pact in
their ability to use fiscal policy, would the ability to alter exchange rates be a more significant
mechanism of adjustment than at present, were it still to exist. Introduction. This chapter focuses on
the following questions. If, on the other hand, the shock is purely financial - an example quoted by
the Commission is a shock to the domestic money supply process - the correct answer is fixed
exchange rates, or a single currency, which minimises the impediments to money flows across
national borders. Optimum Currency Areas and the European Experience. Premise: a government
wishes to raise a given sum through taxation but recognises that taxes distort choice. The business
cycle depicts the increase and decrease in production output of goods and services in an economy.
This would, in turn, help to determine whether the optimum currency area in the European Union is
still in existence today and whether it has potential to expand and generate benefits for its future
members. Critique of OCA-theory can be formulated at three different levels: How relevant are the
differences between countries. Philadelphia. 6 th December 2006. Ignacio Boixo XBRL Network
Co-ordinator. In other words, business cycles have differing impacts across the euro area, which
lacks the necessary fiscal institutions to cushion the blow in places hit relatively hard. However, in
deciding whether a group of economic regions are candidates to form a monetary union, OCA theory
also considers the prospective benefits. A few researchers did in fact discuss the advantages and
disadvantages of a floating exchange rate. In fact, a logical extension of the arguement applied to
Indian context, would lead to the conclusion that since at any time many Indian states would be out
of sync with the national business cycle (which determines the monetary policy), India does not
correspond to an OCA. Terms of Service 7. Disclaimer 8. Privacy Policy 9. Copyright 10. Report a
Violation 11. A few questions. Would it be desirable for the whole world to have one currency.
Thus, another condition OCA theory suggests regions should satisfy in order to form a monetary
union is that they should have a sufficient degree of trade integration with the other members of the
union, so as to generate benefits from using a common currency. When small twin countries with
identical economic structure are in this situation, their central banks compete to invite more real
capitals to enrich their economy as long as the countries attain full employment. A number of the
peripheral economies of EMU falls well inside the OCA boundary. June 24, 2012. The advantages of
a common currency. Benefits and Costs involved in adopting a common currency. In other words,
geographic regions may be better off using the same currency instead of each country within that
geographic region using its own currency. Acknowledgments to non Supervisors: Walter Hamscher,
Charles Hoffman, Ignacio Hernadez-Ros, Eduardo Carrillo, Allyson Ugarte, Colm O hAonghusa. It
speculates that there is an optimum geopolitical area that should share a currency, but this geopolitical
area doesn’t necessarily correspond with national borders. To see this, suppose that the common
central bank tightens monetary policy (see figure 3 below). FISH-BOL Meetings. Regional Working
Group (RWG) Chairs Meeting, Amsterdam, May 2006. EU is thus the most prominent instance of
the currency area.