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Mundell Revisited: a Simple Approach to the Costs and Benefits of a Single Currency Area

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  • Stephen Ching
  • Michael B. Devereux

Abstract

The paper evaluates the costs and benefits of a single currency area within a unified framework. Conventionally, it is argued that a single currency area carries a welfare loss owing to the sacrifice of exchange rate adjustment in the presence of country‐specific shocks. But in 1973 Mundell argued that a single currency area offers risk‐sharing benefits when capital markets are limited in their ability to facilitate consumption insurance. The authors construct a simple model and compare a system of independent national currencies to a single currency area. The presence of country‐specific shocks may either reduce or enhance the benefits of a single currency area, depending on the importance of exchange rate adjustment relative to risk‐sharing. In a simple quantitative analysis, we find that either regime may dominate, although the utility differences between the two regimes are very small.

Suggested Citation

  • Stephen Ching & Michael B. Devereux, 2003. "Mundell Revisited: a Simple Approach to the Costs and Benefits of a Single Currency Area," Review of International Economics, Wiley Blackwell, vol. 11(4), pages 674-691, September.
  • Handle: RePEc:bla:reviec:v:11:y:2003:i:4:p:674-691
    DOI: 10.1111/1467-9396.00410
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    References listed on IDEAS

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    1. Barry Eichengreen, 1998. "Does Mercosur Need a Single Currency," NBER Working Papers 6821, National Bureau of Economic Research, Inc.
    2. Christian Zimmermann, 1994. "Technology Innovations and the Volatility of Output: An International Perspective," Cahiers de recherche CREFE / CREFE Working Papers 34, CREFE, Université du Québec à Montréal.
    3. Bayoumi, Tamim & Eichengreen, Barry & Mauro, Paolo, 2000. "On Regional Monetary Arrangements for ASEAN," Journal of the Japanese and International Economies, Elsevier, vol. 14(2), pages 121-148, June.
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    Cited by:

    1. Lahiri, Amartya & Singh, Rajesh & Vegh, Carlos, 2007. "Segmented asset markets and optimal exchange rate regimes," Journal of International Economics, Elsevier, vol. 72(1), pages 1-21, May.
    2. Marco Celentani & J. Conde-Ruiz & Klaus Desmet, 2007. "Inflation in Open Economies with Complete Markets," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 31(2), pages 271-291, May.
    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.
    4. Amartya Lahiri & Rajesh Singh & Carlos A. Vegh, 2007. "Optimal Exchange Rate Regimes: Turning Mundell-Fleming's Dictum on its Head," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 54(3), pages 249-270, September.
    5. V. V. Chari & Patrick J. Kehoe, 2003. "On the desirability of fiscal constraints in a monetary union," Staff Report 330, Federal Reserve Bank of Minneapolis.
    6. Ronald I. McKinnon, 2004. "Optimum Currency Areas and Key Currencies: Mundell I versus Mundell II," Journal of Common Market Studies, Wiley Blackwell, vol. 42(4), pages 689-715, November.
    7. Thierry Warin & Phanindra V. Wunnava & Hubert P. Janicki, 2009. "Testing Mundell's Intuition of Endogenous OCA Theory," Review of International Economics, Wiley Blackwell, vol. 17(1), pages 74-86, February.
    8. Ricardo Cabral & Francisco Louçã, 2019. "The euro at twenty: Follies of youth?," Working Papers Department of Economics 2019/02, ISEG - Lisbon School of Economics and Management, Department of Economics, Universidade de Lisboa.
    9. Chari, V.V. & Kehoe, Patrick J., 2007. "On the need for fiscal constraints in a monetary union," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2399-2408, November.
    10. 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.
    11. Masashige Hamano & Pierre M. Picard, 2017. "Extensive and intensive margins and exchange rate regimes," Canadian Journal of Economics, Canadian Economics Association, vol. 50(3), pages 804-837, August.
    12. D’Aguanno, Lucio, 2015. "Monetary Policy and Welfare in a Currency Union," The Warwick Economics Research Paper Series (TWERPS) 1082, University of Warwick, Department of Economics.
    13. J.M.C. Santos Silva & Silvana Tenreyro, 2010. "Currency Unions in Prospect and Retrospect," Annual Review of Economics, Annual Reviews, vol. 2(1), pages 51-74, September.
    14. Agénor, Pierre-Richard & Aizenman, Joshua, 2011. "Capital market imperfections and the theory of optimum currency areas," Journal of International Money and Finance, Elsevier, vol. 30(8), pages 1659-1675.
    15. Klaus Desmet, 2002. "Asymmetric Shocks, Risk Sharing, and the Latter Mundell," Working Papers 0222, Banco de España;Working Papers Homepage.
    16. Monika Blaszkiewicz-Schwartzman, 2007. "Explaining Exchange Rate Movements in New Member States of the European Union: Nominal and Real Convergence," Money Macro and Finance (MMF) Research Group Conference 2006 144, Money Macro and Finance Research Group.
    17. Carsten K. Nielsen, 2009. "Optimal economic institutions under rational overconfidence, with applications to the choice of exchange rate regime," International Journal of Economic Theory, The International Society for Economic Theory, vol. 5(4), pages 375-407, December.
    18. Marc-Alexandre Sénégas, 2010. "La théorie des zones monétaires optimales au regard de l'euro : Quels enseignements après dix années d'union économique et monétaire en Europe ?," Revue d'économie politique, Dalloz, vol. 120(2), pages 379-419.
    19. Kim, Soyoung & Kim, Sunghyun H. & Wang, Yunjong, 2006. "Financial integration and consumption risk sharing in East Asia," Japan and the World Economy, Elsevier, vol. 18(2), pages 143-157, March.
    20. D'Aguanno, Lucio, 2015. "Monetary Policy and Welfare in a Currency Union," Economic Research Papers 270012, University of Warwick - Department of Economics.
    21. Ignazio Angeloni & Michael Flad & Francesco Paolo Mongelli, 2005. "Economic and monetary integration of the new Member States - helping to chart the route," Occasional Paper Series 36, European Central Bank.
    22. Ricardo Cabral & Francisco Louçã, 2019. "The euro at twenty: Follies of youth?," Revista de Economía Crítica, Asociación de Economía Crítica, vol. 27, pages 59-69.
    23. Pierre M. Picard & Tim Worrall, 2015. "Currency Areas and Voluntary Transfers," CREA Discussion Paper Series 15-12, Center for Research in Economic Analysis, University of Luxembourg.

    More about this item

    JEL classification:

    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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