In economics, an optimum currency area (OCA), also known as an optimal currency region (OCR), is a geographical region in which it would maximize economic efficiency to have the entire region share a single currency. The underlying theory describes the optimal characteristics for the merger of of the optimal currency area was pioneered by economist Robert Mundell. The theory of optimum currency areas (OCA) explores the criteria as well as first time that someone used the phrase optimum currency area was Mundell. In Canadian economist Robert Mundell published his theory of the optimal currency area (OCA) with stationary expectations. He outlined.

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Account Options Sign in. Center for Ageas Employment and Price Stability. The possibility of adopting a more moderate inflation rate if the rest of the world is unstable and the country in question is stable; the necessity of adopting a higher inflation rate if the country is incapable of managing its fiscal and monetary policy in a stable manner.

Optimum currency area

Journal of Economic Literature. Mundell takes the example of North America. Europe exemplifies a situation unfavourable to a common currency. The United States is pptimum good example: Views and Commentaries for The Economics of European Integration.

This logic suggests that the OCA criteria can be self-fulfilling.

Optimum currency area – Wikipedia

Mundell was an ardent supporter of the euro, of which he is considered the godfather. Accordingly, for a small country or for a region where the share of imports and exports in GDP is large, the effects of a devaluation on price levels will be immediate, and the money illusion will quickly disappear. A harvest failurestrikesor war, in one of the countries causes a loss of real income, but the use of a common currency or foreign exchange reserves allows the country to run down its currency holdings and cushion the impact of the loss, drawing on the resources of the other country until the cost of the adjustment has been efficiently spread over the future.

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Specifically, Keynesian economists argue that fiscal stimulus in the form of deficit spending is the most powerful method of fighting unemployment during a liquidity trap. Long-run costs for the nation as a whole are bartered away by governments for what they presume to be short-run political benefits. Rather than moving toward more flexibility in exchange rates within Europe the economic arguments suggest less flexibility and a closer integration of capital markets.

Once individual firms can easily serve the whole OCA market, and not just their national market, they will exploit economies of scale and concentrate production. For Mundell, the existence of a stable monetary anchor is essential. Retrieved from ” https: Budapest Open Access Initiative. In the previous example, if there were a central bank in the West, it could lower its interest rates to combat unemployment, while the central bank in the East could raise its interest rates to combat inflation.

Additional criteria suggested are: Supposing that the currency is managed properly, the larger the area, the better. The European Monetary Union is an eminently political instrument that can be understood only in light of historical developments in the old continent.

In contrast with the previous model, asymmetric shocks are not considered to undermine the common currency because of the existence of the common currency. Hence, a region of Germany could join with a region of France to create their own currency and abandon the mark and the franc. To understand the notion of asymmetrical shock and the role of the exchange rate, let us assume with Mundell that Western Canada produces forestry products, and the East, automobiles.

The relationship between these two new currencies, which would replace the Canadian dollar and the Gheory States dollar, would be governed by a floating exchange rate. Mundell’s work can be cited on both sides of the debate about the euro. For Mundell, money illusion of this type cannot be expected to last for very long.

Views & Commentaries

The potential disadvantages would come from the elimination of the exchange rate between participants in the union: The four often cited criteria for a successful currency union are: It follows that for an open, diversified economy, the benefits of joining a monetary union in terms of gains in liquidity and financial stability can offset the additional adjustment costs that could result from its joining the union.

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To these two criteria, the following must be added: In theory, an optimal currency area could also be smaller than a country.

First, the argument that floating exchange arrangements are superior to fixed exchange arrangements z to a common currency for mitigating the effects of asymmetrical shocks is based, as Mundell’s article explicitly points out, on the existence of money illusion.

If instead, the European currencies were bound together disturbances in the country would be cushioned, with the shock weakened by capital movements. This implies that any proposal of a union of existing states could be rejected on grounds of nonoptimality, if the term optimality is to be given its strict meaning.

Views Read Edit View history. If capital and labor shift from the industries that have suffered from a decline in demand toward those enjoying surplus demand, from the West toward the East in our example, balance can be restored in the stability of prices and employment.

Here Mundell tries to model how exchange rate uncertainty will interfere munell the economy; this model is less often cited. Second, within a single country, capital mobility can take the place of labor mobility in facilitating adjustment. Robert Mundell laid the theoretical foundations for the European Monetary Union.

For a currency area to be optimal strictly speaking, it must nearly always be necessary for various regions of a single state to join with different monetary aeas, each having its own currency. However, he found the fit of the Southeast and Southwest to mubdell questionable. Published by Mundell in[3] this is the most cited by economists.