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 of the optimal currency area was pioneered by economist Robert Mundell. The theory of optimum currency areas (OCA) explores the criteria as well as first time that someone used the phrase optimum currency area was Mundell. In Canadian economist Robert Mundell published his theory of the optimal currency area (OCA) with stationary expectations. He outlined.
Optimum currency area – Wikipedia
To understand the notion of asymmetrical shock and the role of the exchange rate, let us assume with Mundell that Western Canada produces forestry products, mundll the East, automobiles.
The relationship between these two muundell currencies, which would replace the Canadian dollar and the United States dollar, would be governed by a floating exchange rate. To respond to this question, Mundell develops a cost-benefit analysis of the monetary union. According to a recent study by Richard Baldwin, a trade economist at the Graduate Institute of Mundell Studies in Geneva, the boost to trade within the Eurozone from the single currency is much smaller: Most economists cite muhdell the first stationary expectations model, and conclude against the optimality of the euro.
It follows that for an open, diversified economy, the benefits of joining a monetary union in theiry of gains in liquidity and financial stability can offset the additional adjustment costs that could result from its joining the union.
Some economists have argued that the United States, for example, has some regions that do not fit into an optimal currency area with the rest of the country. However, it has lower labour mobility than the United States, possibly due to language and cultural differences. If, on the other hand, the two countries use separate monies with flexible exchange rates, the whole loss has to be borne alone; the common currency cannot serve as a shock absorber for the nation as a whole except insofar as the dumping of inconvertible currencies on foreign markets attracts a speculative capital inflow in favor of the depreciating currency.
Retrieved 24 July If specialization increases, each country will be less diversified and will face more asymmetric shocks; weakening the case for the self-fulfilling OCA argument. The terms of trade between the West and the East deteriorate.
At the top of the list is an absence of frequent, large-scale asymmetrical shocks and mobility in the factors of production.
For instance, part of the rationale behind the creation of the euro is that the individual countries of Europe do not each form an optimal currency area, but that Europe as a whole does. Specifically, Keynesian economists argue that fiscal stimulus in the form of deficit spending is the most powerful method of fighting unemployment during a liquidity trap. Published by Mundell in this is the most cited by economists.
Beyond the primarily economic and technical considerations, Mundell’s concern was also to place the creation of the euro in a broader perspective, that of the international monetary system, whose operations he analyzed, perhaps better than anyone else, in his work. Journal of Economic Literature. So despite a less fine tuned monetary policy the real economy should do better.
Once individual firms can easily serve the whole OCA market, and not just their national market, they will exploit economies of scale and concentrate production.
Optimum currency area
Firstly, the self-fulfilling effect’s impact may not be significant. Meade labor mobility mand means of payment Monetary Dynamics money illusion multiregional countries national currencies national money supplies number of currencies optimum currency area ployment pressure in region real income regional currency areas rency area separate currency single currency area stabilization argument stabilization policy surplus currnecy system of flexible terms of trade Tibor Scitovsky tion tional currencies unemployment in deficit unit of account United States dollar variable exchange rates West Western dollar Western Europe.
Here asymmetric shocks are considered to undermine the real economy, so if they are too important and cannot be controlled, a regime with floating exchange rates is considered better, because the global monetary policy interest rates will not be fine tuned for the particular situation of each constituent region.
The price of automobiles will tend to increase, leading to a general rise in prices in the East; conversely, prices will tend to decline in the West, as a result of a fall in the price of forestry products. Scott Adjustment Under Fixed argument for flexible assume bank can expand based on national capital mobility causes unemployment central banks common currency currency area comprising degree of factor degree of money East Econ economists entities exchange rates based experimented with flexible factor immobility factors are mobile fixed exchange rates flexible ex flexible exchange rates flexible exchange system gions gold standard inflationary pressure internal factor mobility International Adjustment International Disequilibrium interregional J.
In theory, an optimal currency area could also be smaller than a country. And the monetary union itself is a factor of integration which will at the same time increase the mobility of the factors of production and reduce the probability of asymmetrical shocks.
This shock is asymmetrical to the extent that it creates a surplus demand for products from the East and optkmum surplus supply of products from the West.
An optimal currency area is often larger than a country. Currenc, for most parts of the Eurozone, such levels of labour mobility and labor market integration remain a distant prospect.
Additional criteria suggested are: Login or Register Information of interest. Our Nobel prize winner was therefore being neither inconsistent nor schizophrenic when he supported the idea of a monetary union in Europe in the s.
The labor factor, which already has little mobility within certain countries, is even less mobile in the region as a whole. Subsequently, this process further ensures that the Eurozone meets the OCA criteria. In fact, the U. Such stimulus may not be possible if states in a monetary union are not allowed to run sufficient deficits. The Journal of Economic Perspectives. Hence, a region of Germany could join with a region of France to create their own currency and abandon the mark theorh the franc.
Supposing that the currency is managed properly, the larger the area, the better.
Mundell’s work can be cited on both sides optimhm the debate about the euro. In the previous example, if there were a central bank in the West, it could lower its interest rates to combat unemployment, while the central bank in the East could raise its interest rates to combat inflation.
If capital and labor shift from the industries that have suffered from a decline in demand toward those enjoying surplus demand, from the West toward the East in our example, balance can be restored in the stability of prices and employment.
Mundell was an ardent supporter of the euro, of which he is considered the godfather.
Let us imagine a change in consumer tastes that pushes up the demand for automobiles and compresses that for forestry products. The more open the economy, the more sensitive it will be to shocks and the less stable and liquid its currency will be.