The Optimum Currency Areas Theory

Topics: Monetary policy, Currency, Optimum currency area Pages: 4 (1265 words) Published: May 7, 2011
1. Introduction:
The Optimum currency areas theory is the seminal contributions developed by Mundell (1961), it attempts to answer a question under which conditions a certain country would like to join a fixed exchange rates system. According to Krugman (2000), if the monetary efficiency gain of one country exceeds its economic stability loss, the country will wish to join a monetary union/ a fixed exchange rate system.

In this paper, the theory of optimum currency areas will be analysed in part 2. In part 3, we will assess whether Europe integration satisfies the conditions of the characteristics of OCA from the view the Optimal Currency Area criteria. In part 4, the Europe counties' options in Post Bretton-Woods era will be described and discussed. Part 5 is a concluding part, in which we summarize the main points of this paper.

2. The theory of Optimum currency areas.
The theory of optimum currency areas (OCA) attempts to answer a question under which conditions a certain country would like to join a monetary union /fixed exchange rates system, instead of having a different currency. The Optimum currency areas theory is the seminal contribution developed by Mundell (1961), although some insights were introduced already in Friedman (1953 cited in Francesco, 2002) and Meade (1957 cited in Francesco, 2002).

The implication of the OCA theory is that the country would wish to fix its exchange rate to other countries with whom it is closely linked its own economy through trade and capital flow. The difference between the monetary efficiency gain and the economic stability loss from joining a monetary union is a decisive factor for the country's decision to join the monetary union or an exchange rate area. (Krugman&Obstfeld, 2000).

A group of countries will benefit from forming a fixed exchange rate system if the following conditions are satisfied. These conditions are: the extensive trade among a group of countries because transaction costs would be...
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