Optimum Currency Areas: Theory and Applications

Abstract

The paper is aimed at providing an extensive analysis of the theory of an
optimum currency area (OCA), one of the most controversial and incomplete
topics in economics. Nonetheless, high possibility of practical implementation
alongside with real world examples made it a popular topic for discussions
among researchers and policy makers. Although early literature in the field
was written in the 1950s, Robert Mundell was the first to use the term of an
optimum currency area. Other pioneering authors who are considered to
be founders of the theory are Peter Kenen and Robert McKinnon. Their
works, however, have also established a number of paradoxes. This, in turn,
gave birth to the “new OCA generation”. The main contributions to the
OCA theory at this stage were made by Giercsh, Corden, Magnifico. The
previously mentioned authors belong to the traditional OCA researchers.
The modern theory, which emerged after the eurozone creation, broadened
classical literature by considering the recent macroeconomic developments of
the times. The literature, which is discussed in the first chapter of the paper,
highlights the following key determinants of the OCA: similarities in shocks,
inflation, business cycles, attitudes to policy, high factors’ mobility, trade
integration, price and wage flexibility, openness, and political and historical
reasons. Due to limited data availability, the empirical part of this paper tests
only a portion of these factors. It is performed with the use of econometric
techniques and in accordance with the methodology discussed in Chapters 2
and 3, respectively. Generally, the findings indicate that, although theoretical
hypothesis and methodologies are true and applicable to European countries,
to some extent unexpectedly, the results are obtained in a broader scope. This
finding confirms the assumption of Tower and Willett, and Ishayama, who
stressed that the OCA criteria are individual for each region. The empirical
part also presents potential currency areas, which were determined with the
use of OCA and BCS indexes. Although some of the currency areas seem
to be achievable, low predictable power of the models should be taken into
account while considering the findings.