Some recent developments and discussions. Under fixed exchange rate regime and in the absence of capital controls, a high level of reserves is required to deal with speculative capital flows. Rules rather than discretion: Some of the most important criteria include labour mobility, price and wage flexibility, degree of openness, product diversification, inflation differentials, effectiveness of monetary policy, correlation and variation of shocks, character of shocks and political factors. The Theory of Optimum Currency Areas: However, Berger, Jensen and Schjelderup question the very importance of symmetric shocks. Papers and Proceedings, 37 2 , —
Even though many additional criteria have been introduced in this modern phase, traditional contributions are still relevant. History of Political Economy, 38 4 , — Economics Letters, 73 2 , — Weltwirtschaftliches Archiv, 1 , 1— This raises the question: De Grauwe , while using the theory of Bruno and Sachs , differentiates among the three types of labour market centralisation and the implications they pose for joining a currency union. Journal of Monetary Economics, 12 1 , —
The widely held views of the time were: Throughout his career, Friedman was an advocate of both types of cuurrency see, for instance, Friedman, A Literature Review’, Privredna kretanja i ekonomska politika15str.
The theory of optimum currency areas : a literature review – EconBiz
In the presence of dominant monetary shocks, a fixed exchange rate provides more stability, while floating exchange rate is preferable if shocks are real or external. Review of International Economics, 17 174— Canada and flexible exchange rates. A Literature Review Broz, Tanja. Through this paper, Downloaded from rmi.
In contrast, the recent litera- ture believes inflation prevention as the main macroeconomic objective of a central bank, with a secondary objective of dampening business cycle fluctuations. We trace the developments of the OCA theory which Downloaded from rmi.
The result of this process is higher nominal wages and higher inflation, with same real wages as before. In Milton Friedman Ed.
Ishiyama became one of the first to acknowledge that there should not be only one criterion in determining an OCA. Boulding calls them macroeconomic paradoxes. In fact, the origins of the theory of OCA can be traced back to the long-standing debate about the merits of fixed versus floating exchange rates Ishiyama, On the indeterminacy of equilibrium exchange rates. The Theory of Optimum Currency Areas: A Plan for a European Currency.
Sweden, Finland, Austria; Schengen Treaty takes effect some countries Among other things, the Treaty of Amsterdam updates Maastricht and further prepares eastward expansion; Stability and Growth Pact Eurozone introduced Members: For example, the timing of monetary stabilizations in inlationary economies, the value at which currencies enter a ixed exchange rate regime, and exchange rate realignments are instances of monetary policy decisions that depend on the realization of political shocks.
Even though many additional criteria have been introduced in this modern phase, traditional contributions are still relevant. The case for flexible exchange rates. In other words, the wage contracts and prices will be highly influenced by the changes in prices of tradables groz the changes in exchange rate.
The Theory of Optimum Currency Areas: A Literature Review
Contractionary effects of devaluation. If the nominal interest rate on the government debt raised to smooth adjustment to a shock exceeds the nominal growth rate of the economy, a debt dynamic that leads to an ever-increasing government debt relative to country size in terms of GDP is set in motion De Grauwe,pp.
Third, a situation in which there are two countries, the USA and Canada, with independent currencies and two regions, East and West, which run across these two countries. Alternative Exchange Rate Regimes One can see the discussion on the OCAs as a part of the problem of how to choose optimum exchange rate regime.
The Economic Journal,— To revieww this point, suppose an economy experiences a negative terms of trade shock so that its nominal exchange rate depreciates.
Such a Downloaded from rmi. A theory of optimum currency areas. In such a monetary union, with a regional central bank assigned the objective of price stability, the less developed economy face the following situations: Monetary union and economic integration.
Formation of a common currency area will be more costly among coun- tries that have different inflation rate preferences. For example, Alesina, Barro and Tenreyero argue brlz the higher the association of shocks between countries, the lower the costs of giving up an independent monetary policy, while Calvo and Reinhart emphasise that the loss of monetary policy will not be a significant cost if the monetary authority of a country is unable to use its monetary policy adequately.