Help Center Find new research papers in: This means that there will be no need of having their own exchange rates, but one common monetary policy will be satisfactory to both the regions. Economic theory and western European integration. Assume that East experiences a rise in productivity asym- metric demand shock. Formation of a common currency area will be more costly among coun- tries that have different inflation rate preferences. Melitz makes a similar observation: He argues that more open economies favour fixed exchange rates, while flexible exchange rates are more advantageous for more closed economies.
More specifically, the theory of OCAs is devoted to such an analysis. European product market integration after the euro. In such a monetary union, with a regional central bank assigned the objective of price stability, the less developed economy face the following situations: These shocks will cancel each other because diversification will provide some insulation, and there will be no need of frequent changes in the terms of trade via the exchange rate. Does a country gain maximum benefits when it uses its own currency? As discussed above, the theory of OCA proposes that using a com- mon currency creates benefits as well as costs for the member countries. This branch of literature deals with the issues pertaining to the properties and optimal choice of the exchange rate regime.
The second approach deals with the choice of an optimal exchange rate regime in the context of stabilisation plans.
Canadian Journal of Economics, 3 2— The reverse also applies. Finally, the lietrature section concludes. The trade effect of the euro in historical perspective.
Exchange rate regimes in the transition economies: Over the years, the theory of OCA reflected a shift from the criteria that emphasise the state of the economy such as labour mobility, openness and product oc towards the criteria that depend on desired policy trade-offs including similarity of rates of inflation, degree of policy integration, degree of currendy and price flexibil- ity and real exchange rate variability and so on.
Ingram listed the integration of financial markets among the conditions of monetary union. Weltwirtschaftliches Archiv, 2— Money and economic development: The University of Chicago Press. These advancements are discussed, in detail, as follows. Economic Inquiry, 45 11— An implication of this is that in the presence of high capital mobility, the only two literzture options are floating rates or currency unions, but no intermediate regime solutions see, among others, Eichengreen, In his model, a currency union can raise the welfare of the Downloaded from rmi.
Rreview the authorities of the economy in question aim at stabilising the general price level, the rise in the price of tradables, because of the exchange rate depreciation, require a contraction in domestic demand to push down the price of non- tradables. Even though many additional criteria are introduced in this modern phase, traditioal contributions are still relevant.
It was their rejection of the paradigm of groz exchange rates regime that set them apart from Mundell. The interaction of monetary policies in a group of European countries.
Suppose a less diversified country producing only one product, which it also exports, is hit by a negative demand shock, resulting in reduction in its export sales. This suggests the desirability of flexible exchange rates, contrary to the inference drawn from openness criterion.
The Theory of Optimum Currency Areas: A Literature Review
Through this paper, Downloaded from rmi. Papers and Proceedings, 37 2— The higher the level of fiscal integration between two regions, the greater is their ability to smooth asymmetric shocks through fiscal transfers from a low unem- ployment region to a high unemployment region. Reforms in Eastern Europe. Economic Policy, 1 2— In other words, the main objective of this approach was to stabilise a high inflation country with minimal costs of adjustment.
The theory of optimum currency areas : a literature review
Labour Market Frictions In determining whether to enter a common currency area, several more issues are important to consider. A Plan for a European Currency. Thus, sector-specific shocks might become country-specific shocks.
Theory of Optimum Currency Areas: Endogeneity versus Specialisation Hypothesis The litreature OCA theory argued that an economic area has to be opti- mal before using a common currency or a fixed exchange rate mecha- nism. Journal of International Money and Finance, 28 7— American Economic Review, 85 3— European product market integration after the euro. On exchange rate unification.
Thus, the similarities of inflation rates might result from joining a currency union and hence is not a necessary precondition Gandolfo,