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Is Iceland an Optimal Currency Area?

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  • Willem H. Buiter

Abstract

The paper considers the pros and cons for Iceland adopting the euro as legal tender. The current Icelandic monetary arrangements are contrasted both with a unilateral adoption of the euro and with a full membership in the EMU. Microeconomic transactions costs savings argue in favour of either form of monetary union. Loss of seignoirage revenues does not seem to be an economic obstacle to either form of euroisation for Iceland. Loss of the lender of last resort is, however, a powerful argument against unilateral monetary union. The optimal currency area arguments (which concern the macroeconomic stabilization aspects of a permanently fixed exchange rate) are unfavourable to a unilateral monetary union, but the case against a full membership in the EMU is more balanced. The extraneous instability and excess volatility inherent in a marketdetermined exchange rate dominate the shock absorber properties of a flexible exchange rate when financial markets are highly integrated. On balance, the economic arguments favour a membership in the EMU, but not the unilateral adoption of the euro. Because Iceland is not a member of the EU, the political arguments against any form of monetary union are overwhelming. Without a EU membership, the transfer of national sovereignty to the ECB would lack political legitimacy. The lack of institutions for ensuring the political accountability of the ECB in Iceland means that euroisation of Iceland is unlikely to happen, except as part of Icelandic membership in the EU. Euroisation without a membership in the EU is simply unlikely to survive.

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Bibliographic Info

Paper provided by Department of Economics, Central bank of Iceland in its series Economics with number wp10.

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Date of creation: Aug 2000
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Handle: RePEc:ice:wpaper:wp10

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  1. Bayoumi, Tamim & Masson, Paul R, 1994. "Fiscal Flows in the United States and Canada: Lessons for Monetary Union in Europe," CEPR Discussion Papers 1057, C.E.P.R. Discussion Papers.
  2. Charles Engel & John H. Rogers, 1995. "How wide is the border?," Research Working Paper 95-09, Federal Reserve Bank of Kansas City.
  3. Fidrmuc, Jan & Horvath, Julius & Fidrmuc, Jarko, 1999. "Stability of Monetary Unions: Lessons from the Break-up of Czechoslovakia," Transition Economics Series 10, Institute for Advanced Studies.
  4. W.H. Buiter, 1999. "Alice in Euroland," CEP Discussion Papers dp0423, Centre for Economic Performance, LSE.
  5. Barry Eichengreen., 1996. "On the Links Between Monetary and Political Integration," Center for International and Development Economics Research (CIDER) Working Papers C96-077, University of California at Berkeley.
  6. Masson, Paul R & Taylor, Mark P, 1992. "Common Currency Areas and Currency Unions: An Analysis of the Issues," CEPR Discussion Papers 617, C.E.P.R. Discussion Papers.
  7. Dowd, Kevin & Greenaway, David, 1993. "Currency Competition, Network Externalities and Switching Costs: Towards an Alternative View of Optimum Currency Areas," Economic Journal, Royal Economic Society, vol. 103(420), pages 1180-89, September.
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Cited by:
  1. Nils Bjorksten & Anne-Marie Brook, 2002. "Exchange rate strategies for small open developed economies such as New Zealand," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 65, March.
  2. Lamberte, Mario B. & Milo, Melanie S. & Pontines, Victor, 2001. "NO to ¥E$? Enhancing Economic Integration in East Asia through Closer Monetary Cooperation," Discussion Papers DP 2001-16, Philippine Institute for Development Studies.
  3. Buiter, Willem H, 2000. "Optimal Currency Areas: Why Does The Exchange Rate Regime Matter?," CEPR Discussion Papers 2366, C.E.P.R. Discussion Papers.
  4. Nils Bjorksten, 2001. "The current state of New Zealand monetary union research," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 64, December.

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