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A Modern Reconsideration of the Theory of Optimal Currency Areas

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  • Giancarlo Corsetti

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 unionwide 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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Bibliographic Info

Paper provided by European University Institute in its series Economics Working Papers with number ECO2008/12.

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Date of creation: 2008
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Handle: RePEc:eui:euiwps:eco2008/12

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Keywords: Optimum Currency Area; optimal monetary policy; costs of business cycle; exchange rate regime; international policy cooperation; New Open Economy Macroeconomics;

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References

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  1. Frankel, Jeffrey A & Rose, Andrew K, 1998. "The Endogeneity of the Optimum Currency Area Criteria," Economic Journal, Royal Economic Society, vol. 108(449), pages 1009-25, July.
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Citations

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Cited by:
  1. Balogun, Emmanuel Dele, 2009. "Alternative reconsideration of output growth differrential for the West African Monetary Zone," MPRA Paper 13416, University Library of Munich, Germany.
  2. Vladimir Gligorov & Anna Iara & Michael Landesmann & Robert Stehrer & Hermine Vidovic, 2008. "Western Balkan Countries: Adjustment Capacity to External Shocks, with a Focus on Labour Markets," wiiw Research Reports 352, The Vienna Institute for International Economic Studies, wiiw.
  3. Kolasa, Marcin, 2008. "Structural heterogeneity or asymmetric shocks? Poland and the euro area through the lens of a two-country DSGE model," MPRA Paper 8750, University Library of Munich, Germany.
  4. Sousa, Teresa Vasconcelos e, 2013. "Asymmetries in an open economy model," Journal of International Money and Finance, Elsevier, vol. 33(C), pages 358-380.
  5. Roel Beetsma & Massimo Giuliodori, 2010. "The Macroeconomic Costs and Benefits of the EMU and Other Monetary Unions: An Overview of Recent Research," Journal of Economic Literature, American Economic Association, vol. 48(3), pages 603-41, September.
  6. Ferreira-Lopes, Alexandra, 2010. "In or out? The welfare costs of EMU membership," Economic Modelling, Elsevier, vol. 27(2), pages 585-594, March.
  7. Groll, Dominik, 2013. "When do Countries Benefit from Forming a Monetary Union?," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79787, Verein für Socialpolitik / German Economic Association.
  8. Ioana Laura Valeanu, 2012. "Business Cycle Synchronization In The Euro Area," CES Working Papers, Centre for European Studies, Alexandru Ioan Cuza University, vol. 4, pages 429-400, September.
  9. 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.
  10. Michal SKOREPA, 2013. "Troubles in the Euro Area Periphery: The View through the Lens of a Simple Convergence-Sensitive Optimum Currency Area Index," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 63(2), pages 129-151, May.
  11. Balogun, Emmanuel Dele, 2008. "An alternative reconsideration of macroeconomic convergence criteria for West African Monetary Zone," MPRA Paper 11367, University Library of Munich, Germany.

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