Theory of Optimum Currency Areas and the Balkans

Abstract

The theory of optimum currency areas show which are the optimal conditions for a group of countries sharing the same currency, such theory also points out the costs and benefits of giving up a national currency. There are costs and benefits for countries that decide to use the currency of another country or if they choose to belong to a monetary union. The main cost for a country when it is part of a monetary union is the loss of monetary policy, however if such country has credibility problems in monetary policy (high inflation in the past), this cost is significantly reduced or even it can become a benefit. Countries may choose to use another currency to import credibility (Dollarization or Euroisation), belonging to a monetary union or to create central banks with credibility. There are economies with anchors currencies, that is, economies with credible central banks (with inflation controlled for several years), while on the other hand there are economies that have no anchor currencies and therefore can choose to import credibility from economies with anchor currencies. The aim of this paper is to apply some theoretical elements of the theory of optimum currency areas to Balkans countries. We start to consider the idea that there are anchor currencies and non-anchor currencies on the economies of the world. Starting from the above, it is considered that the anchor currency for the countries of the Balkans is the euro, due to the credibility that the European Central Bank has acquired since its creation to the present. Furthermore, we propose to evaluate the relevance for Balkan countries choose one of the following three options: keep their national currencies, create a new regional currency or to use the euro (Euroisation or to be part of the euro area). To assess the relevance of any of the three options above, we estimate the co-movement of the economies of the Balkans with the eurozone and with themselves, besides we analyse the credibility of central banks in the region (the record in the inflation in the countries of the region), trade flows of the countries of the region with the euro-zone and among themselves, and finally we estimate a political proximity variable (coincidence of voting in the UN General Assembly).