A Modern Reconsideration of the Theory of Optimal Currency Areas
Title: A Modern Reconsideration of the Theory of Optimal Currency Areas
Author: CORSETTI, Giancarlo
Publisher: European University Institute
Series/Report no.: EUI ECO; 2008/12
What can be learnt from revisiting the Optimal Currency Areas (OCA) theory 50 years from its birth, in light of recent advances in open economy macro and monetary theory? This paper presents a stylized micro-founded model of the costs of adopting a common currency, relative to an ideal benchmark in which domestic monetary authorities pursue country-specific efficient stabilization. Costs from (a) limiting monetary autonomy and (b) giving up exchange rate flexibility are examined in turn. These costs will generally be of the same magnitude as the costs of the business cycle. However, to the extent that exchange rates do not perform the stabilizing role envisioned by traditional OCA theory, a common monetary policy can be as efficient as nationally differentiated policies, even when shocks are strongly asymmetric, provided that the composition of aggregate spending tends to be symmetric at unionwide level. Convergence in consumption (and spending) patterns thus emerges as a possible novel attribute of countries participating in an efficient currency area.
Subject: Optimum Currency Area; optimal monetary policy; costs of business cycle; exchange rate regime; international policy cooperation; New Open Economy Macroeconomics; E31
Type of Access: openAccess