Working Paper: CEPR ID: DP847
Authors: Jacques Melitz
Abstract: This paper seeks to integrate more closely the theory of optimum currency areas with the theory of international trade. The currency area is considered as a continuous variable ranging from zero to one: zero if there is no enlargement, and some positive value otherwise, corresponding exactly to the percentage of trade in the enlarged area. The benefits of widening a currency area are then treated in the same way as a reduction in transportation costs. The costs of widening a currency area, in turn, are seen as a drop in the speed of adjustment of the terms of trade to their long-run equilibrium level. On this basis it is shown that the marginal benefits of enlarging a currency area fall, the marginal costs rise, and an optimum size arises. This size depends heavily on the optimal composition of the members, however.
Keywords: optimum currency area; exchange rate regime; trade adjustment; international trade
JEL Codes: F02; F15; F40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| currency area size (F36) | trade volume (F10) |
| currency area size (F36) | speed of adjustment (F32) |
| currency area size (F36) | optimal area size (L25) |