Optimum currency area

In economics, the theory of 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.

It describes the optimal characteristics for the merger of currencies or the creation of a new currency. The theory is used often to argue whether or not a certain region is ready to become a currency union, one of the final stages in economic integration.

An optimal currency area is often larger than a country. For instance, part of the rationale behind the creation of the euro is that the individual countries of Europe do not each form an optimal currency area, but that Europe as a whole does form an optimal currency area. The creation of the euro is often cited because it provides the most modern and largest-scale case study of an attempt to engineer an optimum currency area, and provides a comparative before-and-after model by which to test the principles of the theory.

In theory, an optimal currency area could also be smaller than a country. Some economists have argued that the United States, for example, has some regions that do not fit into an optimal currency area with the rest of the country.

The theory of the optimal currency area was pioneered by economist Robert Mundell. Credit often goes to Mundell as the originator of the idea, but others point to earlier work done in the area by Abba Lerner.

Published by Mundell in 1961, this is the most cited by economists. Here asymmetric shocks are considered to undermine the real economy, so if they are too important and cannot be controlled, a regime with floating exchange rates is considered better, because the global monetary policy (interest rates) will not be fine tuned for the particular situation of each constituent region.

The four often cited criteria for a successful currency union are:

Additional criteria suggested are:

Europe exemplifies a situation unfavourable to a common currency. It is composed of separate nations, speaking different languages, with different customs, and having citizens feeling far greater loyalty and attachment to their own country than to a common market or to the idea of Europe.

theory has been most frequently applied in recent years to discussions of the euro and the European Union. Many have argued that the EU did not actually meet the criteria for an OCA at the time the euro was adopted, and attribute the Eurozone's economic difficulties in part to continued failure to do so. While Europe scores well on some of the measures characterising an OCA such as symmetry of shocks. By looking at the correlation of a region's GDP growth rate with that of the entire zone, the Eurozone countries show slightly greater correlations compared to the U.S. states. However, it has lower labour mobility than the United States, possibly due to language and cultural differences. In O'Rourke's paper, more than 40% of U.S. residents were born outside the state in which they live. In the Eurozone, only 14% people were born in a different country than the one in which they live. In fact, the U.S. economy was approaching a single labor market in the nineteenth century. However, for most parts of the Eurozone, such levels of labour mobility and labor market integration remain a distant prospect. Furthermore, the U.S. economy, with a central federal fiscal authority, has stabilization transfers. When a state in the U.S. is in recession, every $1 drop in that state’s GDP would have an offsetting transfer of 28 cents. Such stabilizing transfers are not present in both the Eurozone and EU; thus, they cannot rely on fiscal federalism to smooth out regional economic disturbances. The European crisis, however, may be pushing the EU towards more federal powers in fiscal policy.

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