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Optimum currency area theory adopts the presumption that a currency area confers a benefit upon its members by eliminating [[exchange rate risk]]s and reducing transactions costs. Its analysis concerns the extent to which that benefit may be offset by the risk of an additional cost when there is a [[recession]]. Such an additional cost arises when there is a difference between the [[monetary policy]] response to the recession that is appropriate for a member country, and that which is appropriate for the currency area as a whole. When that happens, some member countries may suffer unemployment and other economic costs that they could have avoided if they had retained control over their national monetary policies. It is liable to happen when the currency area experiences an [[asymmetric shock]] which affects the economies of some member countries more than others. | Optimum currency area theory adopts the presumption that a currency area confers a benefit upon its members by eliminating [[exchange rate risk]]s and reducing transactions costs. Its analysis concerns the extent to which that benefit may be offset by the risk of an additional cost when there is a [[recession]]. Such an additional cost arises when there is a difference between the [[monetary policy]] response to the recession that is appropriate for a member country, and that which is appropriate for the currency area as a whole. When that happens, some member countries may suffer unemployment and other economic costs that they could have avoided if they had retained control over their national monetary policies. It is liable to happen when the currency area experiences an [[asymmetric shock]] which affects the economies of some member countries more than others. | ||
The term "optimum currency area" is believed to have been coined by the eminent economist Robert Mundell to denote the theoretical concept of an area in which there are no such offsetting costs. Mundel's analysis demonstrated that a sufficient condition for its definition would be would be either a frictionless migration of labour, or a frictionless adaptation of labour costs, in response to a change in demand<ref>Robert Mundell: ''A theory of Optimum Currency Areas'', American Economic Review, 51 (4), 1961</ref>. | The term "optimum currency area" is believed to have been coined by the eminent economist Robert Mundell to denote the theoretical concept of an area in which there are no such offsetting costs. Mundel's analysis demonstrated that a sufficient condition for its definition would be would be either a frictionless migration of labour, or a frictionless adaptation of labour costs, in response to a change in demand<ref>Robert Mundell: ''A theory of Optimum Currency Areas'', American Economic Review, 51 (4), 1961</ref>. | ||
==Application of the theory to the Eurozone== | |||
The eurozone does not meet Mundell's labour migration or cost flexibility requirements. Labour mobility is low<ref>[http://ec.europa.eu/economy_finance/publications/publication13173_en.pdf Alexandre Janiak and Etienne Wasmer| ''Mobility in Europe'', European Commission, 2008]</ref> and there is limited wage flexibility<ref>[http://ec.europa.eu/economy_finance/publications/publication9587_en.pdf Alfonso Arpaia and Karl Pichelmann: ''Nominal and real wage flexibility in EMU'', European Commission, 2007]</ref>. | |||
<ref> Paul de Grauwe: ''The Political Economy of Monetary Union in Europe'', The World Economy, November 1993</ref> | <ref> Paul de Grauwe: ''The Political Economy of Monetary Union in Europe'', The World Economy, November 1993</ref> | ||
==References== | ==References== | ||
{{reflist}} | {{reflist}} | ||
Revision as of 10:50, 20 February 2011
Optimum currency area theory
Optimum currency area theory adopts the presumption that a currency area confers a benefit upon its members by eliminating exchange rate risks and reducing transactions costs. Its analysis concerns the extent to which that benefit may be offset by the risk of an additional cost when there is a recession. Such an additional cost arises when there is a difference between the monetary policy response to the recession that is appropriate for a member country, and that which is appropriate for the currency area as a whole. When that happens, some member countries may suffer unemployment and other economic costs that they could have avoided if they had retained control over their national monetary policies. It is liable to happen when the currency area experiences an asymmetric shock which affects the economies of some member countries more than others.
The term "optimum currency area" is believed to have been coined by the eminent economist Robert Mundell to denote the theoretical concept of an area in which there are no such offsetting costs. Mundel's analysis demonstrated that a sufficient condition for its definition would be would be either a frictionless migration of labour, or a frictionless adaptation of labour costs, in response to a change in demand[1].
Application of the theory to the Eurozone
The eurozone does not meet Mundell's labour migration or cost flexibility requirements. Labour mobility is low[2] and there is limited wage flexibility[3].
References
- ↑ Robert Mundell: A theory of Optimum Currency Areas, American Economic Review, 51 (4), 1961
- ↑ Alexandre Janiak and Etienne Wasmer| Mobility in Europe, European Commission, 2008
- ↑ Alfonso Arpaia and Karl Pichelmann: Nominal and real wage flexibility in EMU, European Commission, 2007
- ↑ Paul de Grauwe: The Political Economy of Monetary Union in Europe, The World Economy, November 1993