Working Paper: CEPR ID: DP7645
Authors: Harris Dellas; George Tavlas
Abstract: The theory of optimum currency areas was conceived and developed in three highly influential papers, written by Mundell (1961), McKinnon (1963) and Kenen (1969). Those authors identified characteristics that potential members of a monetary union should ideally possess in order to make it feasible to surrender a nationally-tailored monetary policy and the adjustment of an exchange rate of a national currency. We trace the development of optimum-currency-area theory, which, after a flurry of research into the subject in the 1960s, was relegated to intellectual purgatory for about 20 years. We then discuss factors that led to a renewed interest into the subject, beginning in the early 1990s. Milton Friedman plays a pivotal role in our narrative; Friedman's work on monetary integration in the early 1950s presaged subsequent optimum-currency-area contributions; Mundell's classic formulation of an optimal currency area was aimed, in part, at refuting Friedman's "strong" case for floating exchange rates; and Friedman's work on the role of monetary policy had the effect of helping to revive interest in optimum-currency-area analysis. The paper concludes with a discussion of recent analytical work, using New Keynesian models, which has the promise of fulfilling the unfinished agenda set-out by the original contributors to the optimum-currency-area literature, that is, providing a consistent framework in which a country's characteristics can be used to determine its optimal exchange-rate regime.
Keywords: Optimum Currency Areas
JEL Codes: F33; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Friedman's insights (E65) | Mundell's formalization (E19) |
| Mundell, McKinnon, and Kenen's criteria (F32) | conflicting inferences regarding optimality of currency areas (F36) |
| absence of labor mobility and wage price flexibility (F66) | need for separate monetary policies (E49) |
| economic characteristics (P42) | success of currency unions (F36) |