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The theory of optimum currency areas, trade adjustment, and trade

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  • Jacques Mélitz

Abstract

This article seeks to provide a closer integration of the theory of optimum currency areas with the theory of international trade. A currency area is treated as a continuous variable ranging from zero to one: zero if there is no enlargement, and some positive value otherwise, corresponding exactly to the percentge of trade in the enlarged area. The benefits of widening a currency area are then regarded, in terms of conventional trade theory, as equivalent to a reduction in transportation cost. The costs of widening a currency area are seen, instead, with reference to open economy macroeconomics, as a drop in the speed of adjustment of the terms of trade to their long-run equilibrium level. On this basis, it is shown that the marginal benefits of enlarging a currency area fall, the marginal costs rise, and an optimum size arises. But this size depends heavily on the optimal composition of the members. Copyright Kluwer Academic Publishers 1996

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File URL: http://hdl.handle.net/10.1007/BF01891898
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Bibliographic Info

Article provided by Springer in its journal Open Economies Review.

Volume (Year): 7 (1996)
Issue (Month): 2 (April)
Pages: 99-116

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Handle: RePEc:kap:openec:v:7:y:1996:i:2:p:99-116

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Web page: http://www.springerlink.com/link.asp?id=100323

Related research

Keywords: optimum currency areas; exchange rate regime; trade adjustment; international trade;

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References

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  1. Dornbusch, Rudiger & Fischer, Stanley & Samuelson, Paul A, 1977. "Comparative Advantage, Trade, and Payments in a Ricardian Model with a Continuum of Goods," American Economic Review, American Economic Association, vol. 67(5), pages 823-39, December.
  2. Jacques Mélitz, 1995. "A suggested reformulation of the theory of optimal currency areas," Open Economies Review, Springer, vol. 6(3), pages 281-298, July.
  3. Tamim Bayoumi and Barry Eichengreen., 1992. "Shocking Aspects of European Monetary Unification," Economics Working Papers 92-187, University of California at Berkeley.
  4. Bayoumi, Tamim & Eichengreen, Barry, 1992. "Shocking Aspects of Monetary Unification," Department of Economics, Working Paper Series qt791143kp, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  5. Cohen, Daniel & Wyplosz, Charles, 1989. "The European Monetary Union: An Agnostic Evaluation," CEPR Discussion Papers 306, C.E.P.R. Discussion Papers.
  6. George S. Tavlas, 1993. "The ‘New’ Theory of Optimum Currency Areas," The World Economy, Wiley Blackwell, vol. 16(6), pages 663-685, November.
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Cited by:
  1. Demopoulos, George D. & Yannacopoulos, Nicholas A., 2001. "On the optimality of a currency area of a given size," Journal of Policy Modeling, Elsevier, vol. 23(1), pages 17-24, January.
  2. Giancarlo Corsetti & Paolo Pesenti, 2002. "Self-validating optimum currency areas," Staff Reports 152, Federal Reserve Bank of New York.
  3. Shu-ki Tsang, 2002. "Optimum Currency Area for Mainland HCina and Hong Kong? Empirical Tests," Working Papers 162002, Hong Kong Institute for Monetary Research.

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