Importance of Productivity in Non-Optimal Currency Areas

Abstract

The devaluation tool has, in an open optimal currency area with monetary sovereignty, a very high weight in determining economic policies to adjust relative costs and interest rates to the situation faced by a country to economic shocks either asymmetric or generalized. The devaluation risk is caused not only by domestic inflation, but by imported inflation as well. If inflation of a nation is greater than the average one of its trading partners and the gap between them is not adjusted by the depreciation of its currency, it will start the process of overvaluation. This overvaluation ends manifesting in a growing lack of competitiveness in its foreign trade with a growing trade deficit, reduced gross domestic product, rising unemployment, and falling wages.