Optimum currency areas, real and nominal convergence in the European Union

António Portugal Duarte,João Sousa Andrade

doi:10.14195/2183-203x_42_1

Abstract

It is well known and widely accepted by economists that the characteristics of the countries of the European Monetary Union (EMU) created in 1999 did not match the requirements of an Optimum Currency Area (OCA). The only criteria for membership of the EMU were nominal. A strict level of convergence in inflation and interest rates was imposed. In addition to the nominal convergence, a process of convergence of nominal and real incomes in the new monetary area was expected to be generated with the monetary integration. After summarizing the criteria for a successful currency area in the context of the OCA theory, we study the real and nominal convergence process for an older group of countries (11) to establish whether or not these countries satisfy the conditions of an OCA. We apply ADF tests, together with the Schmidt-Phillips tests, and we estimate the fractional differential process to overcome the disadvantages of the traditional tests, to test for nominal and real convergence. We conclude that a process of real divergence and nominal convergence does exist, and suggest this is a source of genuine imbalance in the European integration process that can destroy the harmonious development of the European Monetary Union.http://dx.doi.org/10.14195/2183‑203X_42_1

Highlights

In 1961, Robert Mundell published his famous paper entitled “A Theory of Optimum Currency Areas”, in which he presented the idea of an optimal monetary area
We analyze whether the European Union (Eurozone) is an Optimum Currency Area, investigating the existence of real and nominal convergence in a geographical zone in which a restricted group of countries could share the same currency since 1 January, 1999
We explore the process‐ es of real convergence and nominal convergence based on spectral analysis, Hurts indicator, Augmented Dickey-Fuller (ADF) and Schmidt-Phillips unit root tests, and fractionally-integrated processes

Summary

Introduction

In 1961, Robert Mundell published his famous paper entitled “A Theory of Optimum Currency Areas”, in which he presented the idea of an optimal monetary area. A continent of many countries and states, as for example, Europe, can be expected to benefit from having the same currency (Rose, 2004; Frankel and Rose, 2002; Baldwin and Wyplosz, 2009; Eicher and Henn, 2009) acceptable anywhere in the region, and which allows for global trade without incur‐ ring costly transactions. This is one of the main reasons underpinning the Optimum Currency Area (OCA) theory, and it is this that we discuss in this paper.

Methods

Results

Conclusion