Optimum Currency Area Theory Research Articles

Formation of the Integrative Currency Area

Optimal currency area theory is the supporting knowledge base of the European euro area. However, the euro area does not work fluently, and many doubts appear in respect to the theoretical foundations and applied procedures in conducting this project. In particular, the accession of new members is doubtful. This paper develops a diagnosis and proposes modifications to the theoretical foundations of the optimal currency area in line with recent progress of economic thoughts. This progress is focused on application of the triad of abstract notions—capital, labor, and money—and the use of essential motions, among which labor self-financing is the most significant. The consideration leads to the integrative instead of discriminative currency area. An additional aim of this paper is to point out how to reshape the existing discriminative euro area to an area involving states that do not fulfill the Maastricht criterion. The integrative area can involve states with different productivity levels, allowing the criterion of fixed exchange rate to be withdrawn. In addition, the application of self-financing removes the problem of dominating public debts. A significant part of this paper develops a measurement of labor productivity and its application to the procedures involving an exchange rate use.

Can We Expect Convergence through Monetary Integration? (New) OCA Theory versus Empirical Evidence from European Integration

It is argued that the European Union and the Eurozone in particular are only able to survive if they succeed in avoiding and/or overcoming real divergence and excessive macroeconomic disequilibria. The mainstream view in economics is that a monetary union is only efficient or rather sustainable if either there is a certain degree of structural homogeneity, that is if there has been real (institutional-structural) convergence among the member countries before accession (Optimal Currency Area (OCA) Theory), or – alternatively – this real convergence is going to occur soon after accession (‘endogenous’ convergence hypothesis: New OCA Theory). This paper first presents a theoretical foundation and a discussion of this endogenous convergence hypothesis and then offers an empirical analysis on whether or not such an endogenous real convergence has occurred in the European Monetary Union (EMU). The analysis shows and explains that – and why – after EMU accession several (particularly emerging market) member economies have experienced real divergence instead of the desired/hoped for convergence. Finally, the paper draws some political implications.

Currency Integration under Labor Mobility : when Cost is incurred

We assess whether renouncing monetary policy autonomy becomes a cost of currency integration under labor mobility in the framework of the New Open Economy Macroeconomics. Assuming Nash equilibrium among central banks of candidate countries, we find that the forfeiture of monetary policy autonomy becomes a cost when country-specific total factor productivity shocks hit them, labor input weights differ between candidate countries, and country specific shocks on marginal disutility of labor occur. These finer points suggest that it cannot generally be concluded that there is no cost of currency integration under labor mobility, as discussed in the classic Optimum Currency Area theory.

Optimum currency areas: EU case

The interest for optimum currency area theory (OCA), comes from the experience of European monetary union (EMU), development of academic thought, progress in economic theory and econometrics in sense of revaluation of national monetary and fiscal policies and endogenousity of OCA criteria. Sovereign debts in European Union (EU) and evident disparities between member states, raising the question of economic validity of EU in course of generating more costs then gains for member states. OCA theory can, to some extent, provide a framework, which can be used for giving the answer to previous question. OCA criteria are used for that analysis. In this paper, there is historical and theoretical description of origin of this theory, from Mundell - the author of this idea in 1961., as well as the evolution of this theory through the development of criteria and their analysis on EMU. These criteria are used for assessment is a country fit to join a OCA, as well the functioning of one OCA, like EMU or some new in the future.

Determinants of Business Cycles Synchronization in the European Union and the Euro Area

Further economic and monetary integration in Europe is currently on hold due to the crisis and even questions about the possible exile of Greece. Especially in those conditions, it is important, to see whether integrated Europe can handle future problems and if economic and monetary integration can be helpful or rather more problematic. The main aim of this paper is to check to what degree business cycles are synchronized in the Eurozone and the European Union and what the main determinants of business cycles synchronization are. To achieve this, the following steps have been taken. Firstly, we turn to optimum currency area theory, to see what conditions need to be met, if the European Union and the euro area can use common monetary policy to deal with some economic shocks. Then, all necessary methodological explanations are presented. Later on, the preliminary data analysis is employed to see how business cycles and their determinants were acting during the last 20 years. Finally, panel data analysis is used to check how those determinants actually influence business cycles synchronization. The main finding of the article is that even though business cycles synchronization has been progressing in the European Union and the euro area so does the specialization – divergence in production structure. This may result in less synchronized business cycles in the future.

MACROECONOMIC SHOCKS ASYMMETRY: SEE AS AN OPTIMAL CURRENCY AREA

This paper has the goal to evaluate the existence of asymmetry of macroeconomic shocks between the SEE countries. It focuses on the Optimum Currency Area (OCA) theory to determine the readiness of any country to participate in a monetary union. The main goal of the study is to evaluate the OCA criteria for Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Greece, Macedonia, Montenegro, Kosovo, Serbia and Slovenia. The focus will be on the trade and financial links among these countries, the harmonization of business cycles and the similarities in the inflation movements. Going through often cited criteria for a successful currency union the paper will try to give conclusion for the possibilities to use the benefits of the OCA in the region.The paper will contribute with its assumptions that will be used in assessing the feasibility of a common currency area (CCA). That assumption will focus on the existence of the asymmetric shocks that will increase the costs of forming a CCA in SEE countries. In this paper, the comparative analysis of the key variables, policies and recommendations, gives profound basis for making conclusions related to the different macroeconomic policies behavior in terms of bad economic performance. Identification of the imbalances, national or international should give an answer for the dilemmas about the consistency of certain measure in terms of OCA.

Lost at Sea: The Euro Needs a Euro Treasury

The euro crisis remains unresolved even as financial markets may seem calm for now. The current euro regime is inherently flawed. Recent reforms have failed to turn the dysfunctional euro regime into a viable one. The investigation is informed by the cartalist critique of traditional optimum currency area theory (Goodhart 1998). Various proposals to rescue the euro are assessed and found lacking. A Euro Treasury scheme operating on a strict rule and specifically designed not to be a transfer union is proposed here as condition sine qua non for healing the euro's potentially fatal birth defects. The Euro Treasury proposed here is the missing element that will mend the current fiscal regime that is unworkable without it. The proposed Euro Treasury scheme would end the currently unfolding euro calamity by switching policy from a public thrift campaign that can only impoverish Europe to a public investment campaign designed to secure Europe's future. No mutualization of existing national public debts is involved. Instead, the Euro Treasury is established as a means to pool eurozone public investment spending and have it funded by proper eurozone treasury securities.

The Eurozone: Piecemeal Approach to an Optimum Currency Area

Soon after the establishment of the Eurozone it became obvious that the structural differences between member states would not abate, as expected, but rather gradually widen. Although part of the problem can be attributed to the enlargement process, it also relates to asymmetric effects of the common currency and to diverging economic policies. This paper discusses the literature which associates the economic characteristics of EMU with arguments of the optimum currency area (OCA) theory and asks for missing capstones that would meliorate EMU to eventually resemble an OCA. As potential candidates for such building blocks, some sort of fiscal union and lender of last resort may qualify, drawing on the experiences of other currency unions and federal states. The financial and debt crisis has revealed that the endogenous forces within a currency union may be too slow to absorb the shocks originating from the crisis. For a currency union to survive in such a situation it is all the more important that the OCA criteria are met and/or that complementary institutions are in place. However, as actual developments in the Eurozone reveal, the political process of approaching an OCA is piecemeal rather than comprehensive and prompt.

The optimum currency area theory and the EMU

The eurozone crisis has revealed certain shortcomings of the EMU, such as its vulnerability to asymmetric shocks and its inability to act as predicted by the theory of optimum currency areas. Although the share of intra-EU trade has increased since the introduction of the euro, dissimilarities in economic structure combined with high degrees of industrial specialisation have increased the EMU’s vulnerability to asymmetric shocks. Moreover, the lack of labour mobility or a transfer payment system limits the EMU’s crisis adjustment capabilities. However, most of the implemented and proposed stabilisation measures seek to remedy this vulnerability by promoting economic integration, further fiscal discipline and debt redemption.

EСONOMIC AND MONETARY UNION: CORRECTION ОF FAILURES

The articles deals with the initial design failures of the European and Monetary Union which could have lead to the current sovereign debt crisis of some of its member-states. It touches upon issues such as the Theory of Optimum Currency Areas, economic imbalances and situation with the public finances within the EU. The EU makes efforts to implement new initiatives which could prevent the euro area from future crises while debates remain on the best possible options. These initiatives imply not only deepening of economic integration but also of a political one. Under these circumstances reaching a consensus in EU- 27 becomes quite a challenging process and different groupings of countries might appear and this can even more complicate decision-making and functioning of the EU. While the outcome of the reforms is still to be seen in the future, some macroeconomic indicators show that real adjustment process has started in the periphery countries due to urgent measures taken at the EU level. Nonetheless the latter ones have not yet generated what is necessary for a sustained way out of the crisis.

Business cycle coherence and OCA endogeneity testing during the integration period in the European Union

The paper deals with assessing the EU from the new optimum currency area theory perspective. It focuses on measuring of the business cycle coherence applying the composite indicators of output gap similarity and synchronicity. Static as well as dynamic business cycle analysis is applied in the paper. In addition, the OCA endogeneity hypothesis is tested based on results of the business cycle coherence analysis. The results show high general coherence of the business cycles across the EU countries in terms of synchronicity measures. Detailed analysis of the output gap similarity indicates differences in the scale of cyclical deviations and impact of shocks in individual countries in the EU. Also the ability to cope with the crisis as a kind of external shock differs in the EU countries. The results do not provide a clear evidence of the OCA endogeneity hypothesis related to the Euro area member and non-member countries.

Narratives of Optimum Currency Area Theory and Eurozone Governance

Optimum Currency Area theory (OCA) is a body of research that has, since its inception in 1961, been highly influential for the discourse and design of Economic and Monetary Union, exercising a significant hermeneutical force. Nonetheless, there has been little acknowledgement that OCA is the subject of very significant internal disagreement, to the extent that economists writing within the field do not commonly agree upon the ontological foundations of the theory. This entails that the translation of the theory into political reality has been characterised by a series of often mutually contradictory narratives, which build upon schisms in the academic corpus. The political realisation of this can be seen during the negotiations over the 1992 process, where certain aspects of the theory concerning governance (of fiscal policy and preferences for conflict adjudication) have been notably suppressed, capitalising upon the fundamental uncertainty in the theory itself. The final part of the paper goes on to consider the financial crisis, and how OCA theory might aid policy-makers' attempts to induce ex-post convergence, demonstrating the continued relevance of the theory.

The Optimum Currency Area Puzzle

The theory of optimum currency areas, suggesting the redrawing of currency areas across countries or splitting of national money into several currencies, is at odds with the one-money-one-country pattern that has dominated monetary history for 26 centuries. This paper puts forward an equilibrium approach which, by stressing the influence of the border effect on intranational adjustment, solves the puzzle and analyzes the closely related issue of the viability of monetary unions and regional specialization.

International credit, financial integration and the euro

Prospects for the European Monetary Union are inevitably affected by the theoretical presuppositions of the observer. The most common approach, the theory of optimal currency areas, postulates that traded goods are produced by labour and the exchange rate between ‘national’ currencies is the ratio of commodity wages, expressed in monetary units, in different countries. In this analysis the exchange rate and wages are substitutes for obtaining international ‘competitiveness’. Such a view is the basis for current reflections about the future of the euro and the reduction of its difficulties to relative wages rates in different countries of the eurozone. The theory has two important limitations. First, it takes no account of the import intensity of exports, which would require wage adjustments to reinforce exchange rate adjustments, so that wages and exchange rates are necessarily complementary parameters, rather than being substitutes for each other. Hence, exit from the eurozone as a means of closing trade deficits would require additional austerity. Even more importantly, it is a commodity money theory, in which imbalances are accommodated by accumulations of specie or fiat money. However, in a credit economy, banking systems absorb trade imbalances into their balance sheets. Moreover, financial integration means that banking systems throughout Europe are vulnerable to balance sheet risks from exchange rate depreciation in any country in Europe.

Surmounting the Individual: Establishing a Common Currency in Asia – A Case Study of East Asian Economies

In the Ministerial meeting of ASEAN held in 1998, the devastation caused by Asian financial crisis remained the point of contemplation. The participants enthusiastically discussed the need to establish common currency and exchange rate system in order to counter any financial crisis anticipated. The ever-growing financial crisis threatening every region in the world has compelled the economists to acknowledge the elevating need of financial cooperation in their respective territories. This is certainly meant to ensure economic stability at both economic and political level. The authors, in the course of this paper, have focused the need to materialize the ideal of promoting monetary integration in the major economies of South, South East, and North East Asia. Calculating Optimum Currency Area (OCA) Index, the authors in a way present costs and benefits associated with the adoption of this currency union. Demand and supply sides of each economy are tested as a pre requisite of OCA in order to provide a good rationale in favor of selection of regions. For this purpose, Structural VAR Analysis (SVAR) method was employed and innovation accounting is done through variance decomposition of forecast errors, impulse response function and correlation matrix. The theory of OCA has been tested by (i) calculating the OCA index estimated by simple OLS method and (ii) following Bayoumi and Eichengreen extrapolating the variability of exchange rate data. The common consensus drawn from the two approaches adopted implies that there is a good potential in the region excluding China to construct a currency union particularly amongst South and North East Asian economies. It is worth mentioning, however, that some of these will have to work harder to join and become an effective member of this currency merger.

Revenge of the Optimum Currency Area

Revenge of the Optimum Currency Area

A Critical Review of the Theory of Optimum Currency Areas: Perspectives for a West African Single Currency

This article presents a perspective on the driving force between economic and political judgement in the formation of a single currency union. West African rulers have long desired to form a single...

The debt crisis in Ireland

Abstract This paper takes a multidisciplinary approach to analyze the current debt crisis in Ireland. It briefly reviews Irish economic performance from 1980 to 2008 and in particular the Celtic Tiger years. The paper looks at changes in the Irish money supply and its contribution to the Irish housing bubble and the subsequent economic problems facing Ireland. An estimate of the negative wealth effect in Ireland since 2007 is made. Given that Ireland is a small open economy, a number of other factors which are both domestic and international are considered in an attempt to explain what has happened in Ireland, where might Ireland go from here and what lessons can be learnt. These factors include: the theory of political economics, the principal-agent problem, the theory of optimal currency areas, the Balassa Samuelson effect, the dynamics of a capitalist economy, neo-liberalism, European monetary integration, international bond markets and ‘insurance’ that was sold to cover a Eurozone breakup. The Irish culture is considered to differentiate Ireland from other EU countries, in particular, Portugal, Italy, Greece and Spain.

ARE THE "ASEAN PLUS THREE" COUNTRIES COMING CLOSER TO AN OPTIMUM CURRENCY AREA?

This paper aims to investigate whether the East Asian countries — ASEAN5, China, Korea, and Japan — have developed a matching Optimum Currency Area (OCA) theory in recent years because the establishment of stable exchange rate linkages and the enhancement of monetary policy credibility are needed for further economic developments in East Asia. In developing the earlier generalized purchasing power parity (G-PPP) model into an up-to-date nonlinear econometric model and considering the adoption of the Asian Monetary Unit (AMU) into this area, this paper could have positive empirical results, which suggest for forming a common currency area in East Asia.

Thinking About the Euro at Night

From a distant look, two items can be applied to the discussion of the Euro these days: The theory of optimal currency areas and what economists usually do when countries fail. The theory of optimal currency areas serves best as a supplier of arguments, why a certain currency union failed and the Euro is an empirical test on the endogeneity versus the specialisation paradigm. The most powerful instrument the International Monetary Fund usually employs to “save” failing economies, an depreciation, is not available in Euroland. Thus a split of the currencies of failing economies is proposed: With all stocks still denominated in Euro, a transaction currency is introduced for flows. This may help to regain competiveness without leaving the Euro and destroying wealth. With this new rule expectations in financial markets might be fixed.