A THEORY OF OPTIMUM CURRENCY AREAS MUNDELL PDF

May 28, 2019 posted by

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.

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The notion of a currency that does not accord with a state, specifically one larger than a state — formally, of an international monetary authority without a corresponding fiscal authority — has been criticized by Keynesian and Post-Keynesian economistswho emphasize the role of deficit spending by a government formally, fiscal authority in the running of an economy, and consider using an international currency without fiscal authority to be a loss of “monetary sovereignty”.

A harvest failurestrikesor war, in one of the countries causes a loss of real income, but the use of a common currency or foreign exchange reserves allows the country to run down its currency holdings and cushion the impact of the loss, drawing on the resources of the other country until the cost of the adjustment has been efficiently spread over the future.

Optimum currency area – Wikipedia

Journal of European Public Policy. Mundell takes the example of North America. The four often cited criteria for a successful currency union are: The more open the economy, the more sensitive it will be to shocks and the less stable and liquid its currency will be.

For Mundell, money illusion of this type cannot be expected to last for very long. Journal of Economic Literature. Views Read Edit View history. An optimal currency area is often larger than a country.

Published by Mundell in[3] this is the most cited by economists. Rather than moving toward more flexibility in exchange rates within Europe the economic arguments suggest less flexibility and a closer integration of capital markets.

OCA theory has been most frequently applied to discussions of the euro and the European Union. The potential disadvantages would come from the elimination of the exchange rate between participants in the union: The relationship between these two new currencies, which would replace the Canadian dollar and the United States dollar, would be governed by a floating exchange rate.

Here Mundell tries to model how exchange rate uncertainty will interfere with the economy; this model is less often cited. 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.

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These considerations dominated scientific debate on the European Monetary Union, with most analysts concluding that Europe, whether made up of six, eleven, or fifteen countries, did not constitute an optimum currency area, as it met the above-mentioned criteria only partially.

According to a recent study by Richard Baldwin, a trade economist at the Graduate Institute of International Studies in Geneva, the boost to trade within the Eurozone from the single currency is much smaller: This dilemma can be resolved through mobility of the factors of production, and the labor factor in particular.

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.

In theory, an optimal currency area could also be smaller than a country. The Post-Keynesian theory of Neo-Chartalism holds that government deficit spending creates money, that ability to print money is fundamental to a state’s ability to command resources, and that “money and monetary policy are intricately linked to political sovereignty and fiscal authority”. Third, the benefits of a common currency and its integrating effect on other markets, especially financial markets, are often underestimated, or ignored, by “economists” using Mundell’s study to attack the European Ot Union.

The European Monetary Union is an eminently political instrument that can be understood only in light of currwncy developments in the old continent.

Optimum currency area

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, and the East, automobiles. This spreads the shocks in the area because all regions share claims on each other in the same currency and can use them for dampening the shock, while in a flexible exchange rate regime, the cost will be concentrated on the individual regions, since the devaluation will reduce its buying power.

Centre for Economic Policy Research. Europe exemplifies a situation unfavourable to a common currency. The European Union and the financial crisis”. How can one be the author of a theory that criticizes the monetary union and one of the principal spiritual fathers of the euro at the same time? The question is innovative, for Mundell envisaged a new global monetary map from the regional rather than the national viewpoint.

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. Budapest Open Access Initiative. That explains his penchant for monetary systems in which, without going so far as to return to the gold standard, currencies continue to be pegged in one way or another to a precious metal.

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Common terms and phrases A. These economic arguments are supported by social arguments as well.

This logic suggests that the OCA criteria can be self-fulfilling. 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. Read, highlight, and take notes, across web, tablet, and phone. From inside the book.

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The Economics of European Integration. It is symptomatic of an currenct of the hegemony of the United States and represents a counterbalance to the dollar, even if the latter remains the dominant currency. 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.

Hence, a region of Germany could join with a region of France to create their own currency and abandon the mark and the franc. Login or Register Information of interest.

This Canadian economist has strong ties in Europe: 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. That also explains why he areaa an increasing number of countries gravitating toward the two major currencies of the 21st century, the dollar and the euro. Center for Full Employment and Price Stability. In normal usage, monetarists are supporters of the rules requiring growth of the monetary aggregates and floating exchange arrangements.

Some sectors in the OCA might end up becoming concentrated in a few locations.

Firstly, the self-fulfilling effect’s impact may not be significant. 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. To these two criteria, the following must be added: 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 theofy raise its interest rates to combat inflation.

On every occasion when a social disturbance leads to the threat of a strike, and the strike to an increase in wages unjustified by increases in productivity and thence to devaluation, the national currency becomes threatened.