A Survey of Currency Area Theory

Abstract

Economic theory unfortunately does not fit into very easily defined compartments. It would be convenient to argue that the only relevant part of theory, as far as monetary integration in Europe is concerned, is that which has been labelled ‘optimal currency area’ theory; but this is not true. One only needs to examine the possible stages in the movement towards a common currency in Western Europe to appreciate that theory alone cannot provide all the answers. A common currency cannot be introduced instantaneously. Monetary integration may exhibit a number of possible stages; there may be a move initially towards a fixed exchange rate system, and this might be accompanied by various degrees of centralisation in the decision making process. Whether or not monetary and fiscal policies show total, partial, or no supranational control in a currency area will determine the effectiveness of integration and the ability of the participants to achieve economic objectives; for this reason it is worthwhile in this chapter to go outside the theory of optimal currency areas to examine the operation of so called policy-mixes under a fixed exchange rate regime.