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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

Suggested Citation

  • Jacques Mélitz, 1996. "The theory of optimum currency areas, trade adjustment, and trade," Open Economies Review, Springer, vol. 7(2), pages 99-116, April.
  • Handle: RePEc:kap:openec:v:7:y:1996:i:2:p:99-116
    DOI: 10.1007/BF01891898
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    1. 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.
    2. Tamim Bayoumi & Barry Eichengreen, 1992. "Shocking Aspects of European Monetary Unification," NBER Working Papers 3949, National Bureau of Economic Research, Inc.
    3. 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 823-839, December.
    4. Jacques Mélitz, 1995. "A suggested reformulation of the theory of optimal currency areas," Open Economies Review, Springer, vol. 6(3), pages 281-298, July.
    5. George S. Tavlas, 1993. "The ‘New’ Theory of Optimum Currency Areas," The World Economy, Wiley Blackwell, vol. 16(6), pages 663-685, November.
    6. Cohen, Daniel & Wyplosz, Charles, 1989. "The European Monetary Union: An Agnostic Evaluation," CEPR Discussion Papers 306, C.E.P.R. Discussion Papers.
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    Cited by:

    1. Ricci, Luca Antonio, 2008. "A Model of an Optimum Currency Area," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 2, pages 1-31.
    2. Giancarlo Corsetti & Paolo Pesenti, 2015. "Endogenous Exchange-Rate Pass-through and Self-Validating Exchange Rate Regimes," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 18(3), pages 62-89, December.
    3. 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.
    4. Giancarlo Corsetti & Paolo Pesenti, 2002. "Self-validating optimum currency areas," Staff Reports 152, Federal Reserve Bank of New York.
    5. Shu-ki Tsang, 2002. "Optimum Currency Area for Mainland HCina and Hong Kong? Empirical Tests," Working Papers 162002, Hong Kong Institute for Monetary Research.
    6. Mulatu F. Zerihun & Marthinus C. Breitenbach & Francis Kemegue, 2014. "A Greek Wedding In SADC? Testing For Structural Symmetry Towards SADC Monetary Integration," The African Finance Journal, Africagrowth Institute, vol. 16(2), pages 16-33.
    7. Abban, Stanley & Ofori-Abebrese, Grace, 2019. "The Prospect Of ECOWAS Currency Union On Intra-Regional Trade," MPRA Paper 102226, University Library of Munich, Germany.
    8. Friedrich L. Sell, 1996. "On the theoretical determination of optimal currency areas in the framework of club theory," Finnish Economic Papers, Finnish Economic Association, vol. 9(2), pages 126-143, Autumn.
    9. Hefeker, Carsten, 1995. "The political choice and collapse of fixed exchange rates," Discussion Papers, Series II 277, University of Konstanz, Collaborative Research Centre (SFB) 178 "Internationalization of the Economy".
    10. Schor, Armand-Denis, 2000. "La théorie des zones monétaires optimales : l’optimum, le praticable, le crédible et le réel," L'Actualité Economique, Société Canadienne de Science Economique, vol. 76(4), pages 545-576, décembre.

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    More about this item

    Keywords

    optimum currency areas; exchange rate regime; trade adjustment; international trade;
    All these keywords.

    JEL classification:

    • F02 - International Economics - - General - - - International Economic Order and Integration
    • F15 - International Economics - - Trade - - - Economic Integration
    • F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General

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