The Theory of Optimum Currency Areas, Trade Adjustment and Trade
This paper seeks to integrate more closely the theory of optimum currency areas with the theory of international trade. The currency area is considered as a continuous variable ranging from zero to one: zero if there is no enlargement, and some positive value otherwise, corresponding exactly to the percentage of trade in the enlarged area. The benefits of widening a currency area are then treated in the same way as a reduction in transportation costs. The costs of widening a currency area, in turn, are seen 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. This size depends heavily on the optimal composition of the members, however.
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