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A Modern Reconsideration of the Theory of Optimal Currency Areas

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Author Info
Corsetti, Giancarlo

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Abstract

What can be learnt from revisiting the Optimal Currency Areas (OCA) theory 50 years from its birth, in light of recent advances in open economy macro and monetary theory? This paper presents a stylized micro-founded model of the costs of adopting a common currency, relative to an ideal benchmark in which domestic monetary authorities pursue country-specific efficient stabilization. Costs from (a) limiting monetary autonomy and (b) giving up exchange rate flexibility are examined in turn. These costs will generally be of the same magnitude as the costs of the business cycle. However, to the extent that exchange rates do not perform the stabilizing role envisioned by traditional OCA theory, a common monetary policy can be as efficient as nationally differentiated policies, even when shocks are strongly asymmetric, provided that the composition of aggregate spending tends to be symmetric at union-wide level. Convergence in consumption (and spending) patterns thus emerges as a possible novel attribute of countries participating in an efficient currency area.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6712.

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Date of creation: Feb 2008
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Handle: RePEc:cpr:ceprdp:6712

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Related research
Keywords: Exchange Rate Regime; International Policy Coordination; New Open Macro Macroeconomics; Optimal Monetary Policy; Optimum Currency Area;

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Find related papers by JEL classification:
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  2. Giancarlo Corsetti & Philippe Martin & Paolo A. Pesenti, 2005. "Productivity Spillovers, Terms of Trade and the "Home Market Effect"," NBER Working Papers 11165, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 624-60, June. [Downloadable!] (restricted)
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  4. Goldberg, Pinelopi Koujianou & Verboven, Frank, 2001. "The Evolution of Price Dispersion in the European Car Market," Review of Economic Studies, Blackwell Publishing, vol. 68(4), pages 811-48, October.
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  5. Cole, Harold L. & Obstfeld, Maurice, 1991. "Commodity trade and international risk sharing : How much do financial markets matter?," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 3-24, August. [Downloadable!] (restricted)
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  6. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2007. "Optimal Monetary Policy and the Sources of Local-Currency Price Stability," NBER Working Papers 13544, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Bernardino Adão & Isabel Correia & Pedro Teles, 2001. "Gaps and triangles," Working Paper Series WP-01-13, Federal Reserve Bank of Chicago. [Downloadable!]
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  8. Sutherland, Alan, 2004. "International Monetary Policy Coordination and Financial Market Integration," CEPR Discussion Papers 4251, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  9. Beetsma, Roel M.W.J. & Jensen, Henrik, 2005. "Monetary and fiscal policy interactions in a micro-founded model of a monetary union," Journal of International Economics, Elsevier, vol. 67(2), pages 320-352, December. [Downloadable!] (restricted)
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  10. Jeffrey A. Frankel & Andrew K. Rose, 1996. "The Endogeneity of the Optimum Currency Area Criteria," NBER Working Papers 5700, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  11. Michael B. Devereux & Charles Engel, 2003. "Monetary Policy in the Open Economy Revisited: Price Setting and Exchange-Rate Flexibility," Review of Economic Studies, Blackwell Publishing, vol. 70(4), pages 765-783, October. [Downloadable!] (restricted)
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  12. Andrew K. Rose, 2000. "One money, one market: the effect of common currencies on trade," Economic Policy, CEPR, CES, MSH, vol. 15(30), pages 7-46, 04. [Downloadable!] (restricted)
  13. Corsetti, Giancarlo, 2006. "Openness and the case for flexible exchange rates," Research in Economics, Elsevier, vol. 60(1), pages 1-21, March. [Downloadable!] (restricted)
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  14. Kalemli-Ozcan, Sebnem & Sorensen, Bent E & Yosha, Oved, 2004. "Asymmetric Shocks and Risk Sharing in a Monetary Union: Updated Evidence and Policy Implications for Europe," CEPR Discussion Papers 4463, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  15. Jordi Gali & Tommaso Monacelli, 2005. "Optimal fiscal policy in a monetary union," Proceedings, Federal Reserve Bank of San Francisco. [Downloadable!]
  16. Maurice Obstfeld & Kenneth Rogoff, 2002. "Global Implications Of Self-Oriented National Monetary Rules," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 503-535, May. [Downloadable!] (restricted)
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  17. Corsetti, Giancarlo & Pesenti, Paolo, 2005. "International dimensions of optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 281-305, March. [Downloadable!] (restricted)
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  18. Perotti, Roberto, 2005. "Estimating the Effects of Fiscal Policy in OECD Countries," CEPR Discussion Papers 4842, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  19. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October. [Downloadable!] (restricted)
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  20. Adao, Bernardino & Correia, Maria Isabel Horta & Teles, Pedro, 2005. "Monetary Policy with Single Instrument Feedback Rules," CEPR Discussion Papers 4948, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  21. Roberto Perotti, 2005. "Estimating the effects of fiscal policy in OECD countries," Proceedings, Federal Reserve Bank of San Francisco. [Downloadable!]
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  22. Adao, Bernardino & Correia, Maria Isabel Horta & Teles, Pedro, 2006. "On the Relevance of Exchange Rate Regimes for Stabilization Policy," CEPR Discussion Papers 5797, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  23. Robert E. Lucas, 2003. "Macroeconomic Priorities," American Economic Review, American Economic Association, vol. 93(1), pages 1-14, March. [Downloadable!]
  24. Fabio Ghironi & Marc J. Melitz, 2004. "International Trade and Macroeconomic Dynamics with Heterogeneous Firms," NBER Working Papers 10540, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Marcin Kolasa, 2008. "Structural heterogeneity or asymmetric shocks? Poland and the euro area through the lens of a two-country DSGE model," National Bank of Poland Working Papers 49, National Bank of Poland, Economic Institute. [Downloadable!]
    Other versions:
  2. Alexandra Ferreira-Lopes, 2008. "In or Out? The Welfare Costs of EMU Membership," Working Papers ercwp1408, ISCTE, UNIDE, Economics Research Centre. [Downloadable!]
  3. Balogun, Emmanuel Dele, 2008. "An alternative reconsideration of macroeconomic convergence criteria for West African Monetary Zone," MPRA Paper 11367, University Library of Munich, Germany. [Downloadable!]
  4. Balogun, Emmanuel Dele, 2009. "Inflation differential in the West African Monetary Zone (WAMZ) area:Implications for unionization," MPRA Paper 13045, University Library of Munich, Germany. [Downloadable!]
  5. Michael Landesmann & Hermine Vidovic & Vladimir Gligorov & Robert Stehrer & Anna Iara, 2008. "Western Balkan Countries: Adjustment Capacity to External Shocks, with a Focus on Labour Markets," Research Reports 352, The Vienna Institute for International Economic Studies, wiiw. [Downloadable!]
  6. Balogun, Emmanuel Dele, 2009. "Alternative reconsideration of output growth differrential for the West African Monetary Zone," MPRA Paper 13416, University Library of Munich, Germany. [Downloadable!]
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