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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This shock is asymmetrical to the extent that it creates a surplus demand for products from the East and a surplus supply of products from the West. For Mundell, the existence of a stable monetary anchor is essential. First, the argument that floating exchange arrangements are superior to fixed exchange arrangements or to a common currency for mitigating the effects of asymmetrical shocks is based, as Mundell’s article explicitly points out, on the existence of money illusion.
For a currency area theoy be optimal strictly speaking, it must nearly always be necessary for various regions optmum a single state to join with different monetary areas, each having its own currency. 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 tjeory the single currency is much smaller: OCA theory has been most frequently applied to discussions of the euro and the European Union.
This dilemma can optomum resolved through mobility of the factors of production, and the labor factor in particular.
ares 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. The European Union and the financial crisis”. Currency unions International economics Monetary policy.
Optimum currency area
For Mundell, money illusion of this type cannot be expected to last for very long. His theory of optimum currency areas, highlighted in aras Nobel Committee’s citation as one of his most significant scientific contributions, has served since the s as an analytical framework for numerous debates on the validity of the creation of a European currency.
Retrieved 29 April When a state in optium U. Some sectors in the OCA might end up becoming concentrated in a few locations.
Optimum currency area – Wikipedia
Mundell was an ardent supporter of the euro, of which he is considered the godfather. 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.
Most economists yheory preferentially the first stationary expectations model, and conclude against the optimality of the euro. Thus, creating the Eurozone will not only boost trade volume, but also increases the symmetry of shocks.
Such stimulus may not be possible if states in a monetary union are not allowed to run sufficient deficits. A theory of optimum currency areas. Firstly, the self-fulfilling effect’s impact may not be significant.
It is composed of separate nations, speaking different languages, with different customs, and having citizens feeling far greater loyalty and attachment to their own country than to a common market or to the idea of Europe. This logic suggests that the OCA criteria can be self-fulfilling. Moreover, if a country systematically uses the depreciation of its domestic currency to stimulate employment, wages will soon be adjusted, and the stimulating effect will disappear, to be followed by inflation.
The four often cited criteria for a successful currency union are: So despite a less fine tuned monetary policy the real economy should do better. The paradox is merely an illusion, as I will try to explain.
In normal usage, monetarists are supporters of the rules requiring growth of the monetary aggregates and floating exchange arrangements. At the top of the list is an absence of frequent, large-scale asymmetrical shocks and mobility in the factors theeory production.
If, on the other hand, the two countries use separate monies with flexible optimmum 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 lptimum of the depreciating currency.
An empirical analysis of regional business cycles” PDF. The theory is used often to argue whether or not a certain region is ready to become a currency unionone of the final stages in economic integration.
Here Mundell tries to model how exchange rate uncertainty will interfere with the economy; this model is less often cited.
Robert Mundell and the Theoretical Foundation for the European Monetary Union
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 mundrll country until the cost of the adjustment has been efficiently spread over the future.
Retrieved from ” https: Wikipedia articles needing page number citations from July All articles with xurrency statements Articles with unsourced statements from March The price of automobiles will tend to increase, leading to currfncy 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 curdency products.
By looking at the correlation of a region’s GDP growth rate with that of the entire zone, the Eurozone countries show slightly greater correlations compared to the U. If specialization increases, each country will be less diversified and will face more asymmetric shocks; weakening the case for the self-fulfilling OCA argument.
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. This implies that any proposal of a union of existing states could be rejected on grounds of nonoptimality, if the term optimality is to be given its strict meaning. For work that led to the euro, not for his supply-side theory”.
Views and Commentaries arras If capital and curremcy 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.
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. 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”.
In economicsan optimum currency area OCAalso known as an optimal currency region OCRis a geographical region in which it would maximize economic efficiency to have the entire region share a single currency.