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Rethinking Optimal Currency Areas

Author

Listed:
  • Patrick Kehoe

    (Princeton University)

  • Alessandro Dovis

    (Penn State)

  • Varadarajan Chari

    (University of Minneapolis)

Abstract

The classic optimal currency area criterion is that countries with more correlated shocks are better candidates to form a union. We show that when countries have credibility problems this simple criterion must be changed: Symmetric countries gain credibility when joining the union only when the shocks affecting credibility are not highly correlated. Our analysis provides a amended optimal currency area criterion that we argue is more relevant than the classic one. We illustrate our argument both for a reduced form model and for a relatively standard sticky-price general equilibrium model. We argue that our new criterion should lead to a rethinking of the massive amount of empirical work on optimal currency areas.

Suggested Citation

  • Patrick Kehoe & Alessandro Dovis & Varadarajan Chari, 2014. "Rethinking Optimal Currency Areas," 2014 Meeting Papers 826, Society for Economic Dynamics.
    • Handle: RePEc:red:sed014:826
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    Cited by:

    1. Madison, Florian, 2024. "A microfounded approach to currency substitution and government policy," Journal of Economic Theory, Elsevier, vol. 219(C).
    2. Campos, Nauro F. & Macchiarelli, Corrado, 2021. "The dynamics of core and periphery in the European monetary union: A new approach," Journal of International Money and Finance, Elsevier, vol. 112(C).
    3. Saito, Yuta, 2025. "Exit expectations and the optimal design of a currency union," Economics Letters, Elsevier, vol. 247(C).
    4. Hauser, Daniela & Seneca, Martin, 2022. "Labor mobility in a monetary union," Journal of International Economics, Elsevier, vol. 137(C).
    5. Fujiwara, Ippei & Kam, Timothy & Sunakawa, Takeki, 2019. "Sustainable international monetary policy cooperation," Journal of Economic Dynamics and Control, Elsevier, vol. 106(C), pages 1-1.
    6. Louisa Grimm & Sven Steinkamp & Frank Westermann, 2021. "On Optimal Currency Areas and Common Cycles: Are the Acceding Countries Ready to Join the Euro?," CESifo Working Paper Series 9016, CESifo.
    7. Arvai, Kai, 2024. "The political economy of currency unions," Journal of International Economics, Elsevier, vol. 152(C).
    8. Moritz Pfeifer & Gunther Schnabl, 2024. "Monetary Policy, Divergence, and the Euro," CESifo Working Paper Series 11442, CESifo.
    9. Cartapanis, André & Gagnon, Marie-Hélène & Gimet, Céline, 2023. "Financially sustainable optimal currency areas," Finance Research Letters, Elsevier, vol. 58(PA).
    10. Gandjon Fankem, Gislain Stéphane & Fouda Mbesa, Lucien Cédric, 2023. "Business cycle synchronization and African monetary union: A wavelet analysis," Journal of Macroeconomics, Elsevier, vol. 77(C).
    11. Kai Arvai, 2021. "The Political Economy of Currency Unions," Working papers 850, Banque de France.
    12. Chari, V.V. & Pérez, Luis, 2022. "Comment on Iovino, La’O and Mascarenhas, “Optimal Monetary Policy and Disclosure with an Informationally-Constrained Central Banker”," Journal of Monetary Economics, Elsevier, vol. 125(C), pages 173-181.
    13. Yuta Saito, 2022. "A Note on Time Inconsistency and Endogenous Exits from a Currency Union," Games, MDPI, vol. 13(2), pages 1-8, February.
    14. Zuzana Rowland & George Lazaroiu & Ivana Podhorská, 2020. "Use of Neural Networks to Accommodate Seasonal Fluctuations When Equalizing Time Series for the CZK/RMB Exchange Rate," Risks, MDPI, vol. 9(1), pages 1-21, December.
    15. Guo, Dong & Zhou, Peng, 2021. "The rise of a new anchor currency in RCEP? A tale of three currencies," Economic Modelling, Elsevier, vol. 104(C).
    16. Arvai, Kai & Gabriel, Ricardo Duque, 2025. "Gains from commitment: The case for pegging the exchange rate," Journal of International Money and Finance, Elsevier, vol. 158(C).
    17. Matthew Greenblatt, 2020. "Bailouts, Inflation, and Risk-Sharing in Monetary Unions," Atlantic Economic Journal, Springer;International Atlantic Economic Society, vol. 48(3), pages 269-296, September.
    18. Abramson, Boaz & Shayo, Moses, 2022. "International integration and social identity," Journal of International Economics, Elsevier, vol. 137(C).

    More about this item

    JEL classification:

    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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