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Currency Areas, Policy Domains, and the Institutionalization of Fixed Exchange Rates

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  • Peter B. Kenen

Abstract

Emerging-market countries are being urged to choose between freely floating exchange rates and firmly fixed rates supported by strong institutional arrangementsûcurrency boards, monetary unions, or formal dollarization. This paper assesses the benefits and costs of institutionalizing fixed rates by synthesizing and supplementing the theory of optimum currency areas (OCA theory). It shows that (1) OCA theory and related empirical work have been excessively influenced by the special case used originally by Robert Mundell, where exogenous shocks display mirror-image asymmetry; (2) OCA theory ignores a vital difference between the domains of monetary policy under a monetary union and other institutional arrangements; (3) because it neglects the way in which a monetary union reduces the debt-creating effects of fiscal stabilizers, OCA theory understates the strength of the case for combining a monetary union with a fiscal federation. The paper also criticizes recent work by Jeffrey Frankel and Andrew Rose in which they claim to show that monetary union reduces asymmetric shocks and thus makes monetary union less costly. The paper suggests that their results may reflect the effects of monetary union on the transmission of shocks rather than their incidence.

Suggested Citation

  • Peter B. Kenen, 2000. "Currency Areas, Policy Domains, and the Institutionalization of Fixed Exchange Rates," CEP Discussion Papers dp0467, Centre for Economic Performance, LSE.
  • Handle: RePEc:cep:cepdps:dp0467
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    Cited by:

    1. Jarko Fidrmuc, 2004. "The Endogenity of the Optimum Currency Area Criteria, Trade, and Labour Market Rigidities: Implications for EMU Enlargement," EUI-RSCAS Working Papers 16, European University Institute (EUI), Robert Schuman Centre of Advanced Studies (RSCAS).
    2. Michael Artis & Toshihiro Okubo, 2008. "The Intranational Business Cycle: Evidence from Japan," Centre for Growth and Business Cycle Research Discussion Paper Series 101, Economics, The Univeristy of Manchester.
    3. Tomas Adam & Robert Ambrisko & Oxana Babecka Kucharcukova & Jan Babecky & Sona Benecka & Jan Bruha & Vilma Dingova & Dana Hajkova & Tomas Holub & Eva Hromadkova & David Kocourek & Lubos Komarek & Zlat, 2014. "Analyses of the Czech Republic's Current Economic Alignment with the Euro Area 2014," Occasional Publications - Edited Volumes, Czech National Bank, Research Department, number as14 edited by Kamila Kulhava & Jakub Mateju, June.
    4. Jarko Fidrmuc & Iikka Korhonen & Ivana Bátorová, 2013. "China in the World Economy: Dynamic Correlation Analysis of Business Cycles," CESifo Economic Studies, CESifo, vol. 59(2), pages 392-411, June.
    5. Stanley Fischer, 2001. "Exchange Rate Regimes: Is the Bipolar View Correct?," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 3-24, Spring.
    6. repec:kap:iaecre:v:13:y:2007:i:1:p:1-18 is not listed on IDEAS
    7. Jan Babecky & Oxana Babetskaia-Kukharchuk & Kamil Galuscak & Dana Hajkova & Jaroslav Hermanek & Tomas Holub & Roman Horvath & Petr Jakubik & Lubos Komarek & Zlatuse Komarkova & Petr Kral & Filip Novot, 2008. "Analyses of the Czech Republic's Current Economic Alignment with the Euro Area 2008," Occasional Publications - Edited Volumes, Czech National Bank, Research Department, number as08 edited by Dana Hajkova, June.
    8. Graham Bird & Ramkishen Rajan, 2002. "The Political Economy of A Trade-First Approach to Regionalism," Centre for International Economic Studies Working Papers 2002-18, University of Adelaide, Centre for International Economic Studies.
    9. Willem H. Buiter, 2010. "Economic, Political and Institutional Prerequisites for Monetary Union Among the Members of the Gulf Cooperation Council," Chapters,in: Currency Union and Exchange Rate Issues, chapter 3 Edward Elgar Publishing.
    10. Fidrmuc, Jarko & Korhonen, Iikka, 2010. "The impact of the global financial crisis on business cycles in Asian emerging economies," Journal of Asian Economics, Elsevier, vol. 21(3), pages 293-303, June.
    11. Graham Bird & Ramkishen Rajan, 2002. "The Evolving Asian Financial Architecture," Centre for International Economic Studies Working Papers 2002-03, University of Adelaide, Centre for International Economic Studies.
    12. Rosmy Jean Louis & Faruk Balli & Mohamed Osman, 2012. "On the choice of an anchor for the GCC currency: does the symmetry of shocks extend to both the oil and the non-oil sectors?," International Economics and Economic Policy, Springer, vol. 9(1), pages 83-110, March.
    13. John Hawkins & Paul Masson, 2003. "Economic aspects of regional currency areas and the use of foreign currencies," BIS Papers chapters,in: Bank for International Settlements (ed.), Regional currency areas and the use of foreign currencies, volume 17, pages 4-42 Bank for International Settlements.
    14. Sánchez, Marcelo, 2005. "Is time ripe for a currency union in emerging East Asia? The role of monetary stabilisation," Working Paper Series 567, European Central Bank.
    15. Tony Cavoli & Ramkishen Rajan, 2003. "Designing Appropriate Exchange Rate Regimes for East Asia: Inflation Targeting and Monetary Policy Rules," Centre for International Economic Studies Working Papers 2003-09, University of Adelaide, Centre for International Economic Studies.
    16. repec:hhs:bofitp:2008_007 is not listed on IDEAS
    17. Balogun, Emmanuel Dele, 2009. "Determinants of West African Monetary Zone (WAMZ)countries global export trade: do foreign reserves and independent exchange rates matter?," MPRA Paper 12929, University Library of Munich, Germany.
    18. Atish R. Ghosh & Anne-Marie Gulde & Holger C. Wolf, 2003. "Exchange Rate Regimes: Choices and Consequences," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262072408, January.
    19. Dumitru, Ionut, 2009. "Adoptarea euro in Romania
      [Euro adoption in Romania]
      ," MPRA Paper 18612, University Library of Munich, Germany.
    20. Balogun, Emmanuel Dele, 2007. "Effects of exchange rate policy on bilateral export trade of WAMZ countries," MPRA Paper 6234, University Library of Munich, Germany.

    More about this item

    Keywords

    Monetary unions; exchange rate regimes; policy domains;

    JEL classification:

    • F3 - International Economics - - International Finance
    • G3 - Financial Economics - - Corporate Finance and Governance

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