Robert A. Mundell

Bio: Robert A. Mundell is an academic researcher from Columbia University. The author has contributed to research in topics: Monetary hegemony & Exchange rate. The author has an hindex of 31, co-authored 95 publications receiving 11238 citations. Previous affiliations of Robert A. Mundell include International Monetary Fund & Johns Hopkins University.

A Theory of Optimum Currency Areas

Abstract: It is patently obvious that periodic balance-of-payments crises will remain an integral feature of the international economic system as long as fixed exchange rates and rigid wage and price levels prevent the terms of trade from fulfilling a natural role in the adjustment process. It is, however, far easier to pose the problem and to criticize the alternatives than it is to offer constructive and feasible suggestions for the elimination of what has become an international disequilibrium system.' The present paper, unfortunately, illustrates that proposition by cautioning against the practicability, in certain cases, of the most plausible alternative: a system of national currencies connected by flexible exchange rates. A system of flexible exchange rates is usually presented, by its proponents,2 as a device whereby depreciation can take the place of unemployment when the external balance is in deficit, and appreciation can replace inflation when it is in surplus. But the question then arises whether all existing national currencies should be flexible. Should the Ghanian pound be freed to fluctuate against all currencies or ought the present sterling-area currencies remain pegged to the pound sterling? Or, supposing that the Common Market countries proceed with their plans for economic union, should these countries allow each national currency to fluctuate, or would a single currency area be preferable? The problem can be posed in a general and more revealing way by defining a currency area as a domain within which exchange rates are fixed and asking: What is the appropriate domain of a currency area? It might seem at first that the question is purely academic since it hardly appears within the realm of political feasibility that national currencies would ever be abandoned in favor of any other arrangement. To this, three answers can be given: (1) Certain parts of the world are undergoing processes of economic integration and disintegration, new experiments are being made, and a conception of what constitutes an optimum currency area can clarify the meaning of these experiments. (2) Those countries, like Canada, which have experimented with flexible exchange rates are likely to face particular problems which the theory of optimum currency areas can elucidate if the national currency area does not coincide with the optimum currency area. (3) The idea can be used to illustrate certain functions of currencies which have been inadequately treated in the economic literature and which are sometimes neglected in the consideration of problems of economic policy. A Theory of Optimum Currency Areas It is patently obvious that periodic balance-of-payments crises will remain an integral feature of the international economic system as long as fixed exchange rates and rigid wage and price levels prevent the terms of trade from fulfilling a natural role in the adjustment process. It is, however, far easier to pose the problem and to criticize the alternatives than it is to offer constructive and feasible suggestions for the elimination of what has become an international disequilibrium system.' The present paper, unfortunately, illustrates that proposition by cautioning against the practicability, in certain cases, of the most plausible alternative: a system of national currencies connected by flexible exchange rates. A system of flexible exchange rates is usually presented, by its proponents,2 as a device whereby depreciation can take the place of unemployment when the external balance is in deficit, and appreciation can replace inflation when it is in surplus. But the question then arises whether all existing national currencies should be flexible. Should the Ghanian pound be freed to fluctuate against all currencies or ought the present sterling-area currencies remain pegged to the pound sterling? Or, supposing that the Common Market countries proceed with their plans for economic union, should these countries allow each national currency to fluctuate, or would a single currency area be preferable? The problem can be posed in a general and more revealing way by defining a currency area as a domain within which exchange rates are fixed and asking: What is the appropriate domain of a currency area? It might seem at first that the question is purely academic since it hardly appears within the realm of political feasibility that national currencies would ever be abandoned in favor of any other arrangement. To this, three answers can be given: (1) Certain parts of the world are undergoing processes of economic integration and disintegration, new experiments are being made, and a conception of what constitutes an optimum currency area can clarify the meaning of these experiments. (2) Those countries, like Canada, which have experimented with flexible exchange rates are likely to face particular problems which the theory of optimum currency areas can elucidate if the national currency area does not coincide with the optimum currency area. (3) The idea can be used to illustrate certain functions of currencies which have been inadequately treated in the economic literature and which are sometimes neglected in the consideration of problems of economic policy.

Capital Mobility and Stabilization Policy Under Fixed and Flexible Exchange Rates

Abstract: The world is still a closed economy, but its regions and countries are becoming increasingly open. The trend, which has been manifested in both freer movement of goods and increased mobility of capital, has been stimulated by the dismantling of trade and exchange controls in Europe, the gradual erosion of the real burden of tariff protection, and the stability, unparalleled since 1914, of the exchange rates. The international economic climate has changed in the direction of financial integration and this has important implications for economic policy. My paper concerns the theoretical and practical implications of the increased mobility of capital. In order to present my conclusions in the simplest possible way, and to bring the implications for policy into sharpest relief, I assume the extreme degree of mobility that prevails when a country cannot maintain an interest rate different from the general level prevailing abroad. This assumption will overstate the case but it has the merit of posing a stereotype towards which international financial relations seem to be heading. At the same time it might be argued that the assumption is not far from the truth in those financial centres, of which Zurich, Amsterdam, and Brussels may be taken as examples, where the authorities already recognize their lessening ability to dominate money market conditions and insulate them from foreign influences. It should also have a high degree of relevance to a country like Canada whose financial markets are dominated to a great degree by the vast New York market.

Inflation and Real Interest

Abstract: THE theory of interest under inflation needs further investigation. Irving Fisher's analysis, which concluded that the money rate of interest rises by the anticipated rate of inflation or falls by the anticipated rate of deflation, was subjected to attack by Keynes: "The mistake lies in supposing that it is the rate of interest on which prospective changes in the value of money will directly react, instead of the marginal efficiency of a given stock of capital."' Fisher himself seems to have had misgivings about the empirical reliability of his explanation and presented evidence suggesting that the adjustment of money interest was only partial, concluding:

The Appropriate Use of Monetary and Fiscal Policy for Internal and External Stability

Abstract: Cette A©tude traite des problA¨mes que pose la rA©alisation de la stabilitA© intA©rieure et de l'A©quilibre de la balance des paiements dans un pays qui estime inopportun de modifier le taux de change ou d'imposer des systA¨mes de contrA´le des A©changes. On suppose que la politique monA©taire et la politique fiscale peuvent Aatre utilisA©es indA©pendamment pour atteindre ces deux objectifs si les flux de capitaux sont sensibles A l'A©cart entre les taux d'intA©rAats, mais on aboutit A la conclusion que la maniA¨re dont les politiques sont assorties aux objectifs revAat une extrAame importance. Plus prA©cisA©ment, il est prouvA© que la politique monA©taire doit Aatre fondA©e sur les objectifs extA©rieurs, et la politique fiscale, sur les objectifs intA©rieurs, et que toute inobservance de cette rA¨gle peut aggraver le dA©sA©quilibre au-delA de ce qu'il A©tait avant l'introduction de changements de politique. Cette thA©orie, lorsque les mesures de stabilisation ne comprennent que la politique monA©taire et la politique fiscale, a pour consA©quences pratiques qu'un pays excA©dentaire subissant une pression inflationniste doit allA©ger les conditions monA©taires et augmenter les impA´ts (ou rA©duire les dA©penses du Gouvernement), alors qu'un pays dA©ficitaire souffrant du chomA¢ge doit relever ses taux d'intA©rAat et abaisser les impA´ts (ou augmenter les dA©penses du Gouvernement). L'explication de ce rA©sultat peut Aatre liA©e A le Principe de la Classification Effective des MarchA©s: les politiques doivent aller de pair avec les objectifs sur lesquels elles ont la plus forte influence relative. Si ce principe n'est pas appliquA©, il se manifestera une tendance vers un mouvement indirect, voire un mouvement instable des variables. L'utilisation de la politique fiscale A des fins extA©rieures et de la politique monA©taire en vue d'assurer la stabilitA© intA©rieure constitue une infraction A ce principe car l'effet du taux d'intA©rAat sur l'A©quilibre intA©rieur, par rapport A son effet sur la balance des paiements, est moindre que l'influence de la politique fiscale sur l'A©quilibre intA©rieur par rapport A son influence sur la balance des paiements. Pour des raisons analogues, la combinaison inverse de ces politiques prA©conisA©e dans les conditions restrictives indiquA©es ici, est compatible avec le principe. A un niveau encore plus gA©nA©ral, on trouve le principe de Tinbergen, d'aprA¨s lequel, pour atteindre un nombre donnA© d'objectifs, il faut au moins un nombre A©gal d'instruments. Le principe de Tinbergen s'attache A l'existence et A la determination d'une solution au systA¨me. Il ne prA©tend pas qu'une sA©rie donnA©e de mesures aboutira en fait A cette solution. Pour soutenir ceci, il y a lieu d'examiner de faA§on approfondie les caractA¨res stabilisateurs du systA¨me dynamique proposA©. Dans cette perspective, le Principe de la Classification Effective des MarchA©s accompagne nA©cessairement le principe de Tinbergen. /// En este estudio se trata de los problemas inherentes a la consecuciA³n de la estabilidad interna y del equilibrio de la balanza de pagos de un paA­s que no considera oportuno modificar su tipo de cambio, o imponer controles al comercio. Se da por sentado que la polA­tica monetaria y la fiscal pueden usarse como instrumentos autA³nomos para lograr los dos objectivos, siempre que los movimientos de capital respondan a los mAirgenes diferenciales de las tasas de interA©s, pero se seA±ala que es asunto de extrema importancia aparear la polA­tica con los objetivos. Se demuestra especialmente, que la polA­tica monetaria debe basarse en objetivos externos y, la fiscal, en objetivos internos y, que el descuido en seguir esta recomendaciA³n, puede empeorar aun mAis la situaciA³n de inestabilidad que existA­a antes de implantar cambios en la polA­tica. La conclusiA³n prAictica de la teorA­a es que cuando las medidas que se toman para lograr la estabilizaciA³n se limitan a la polA­tica monetaria y a la fiscal, aquellos paA­ses con superAivit, que atraviesan por un periodo de presiA³n inflacionista, deben aflojar las condiciones monetarias y subir los impuestos (o reducir los gastos fiscales), mientras que un paA­s deficitario, con problemas de desempleo, debe aumentar las tasas de interA©s y disminuir los impuestos (o incrementar los gastos fiscales). La explicaciA³n de este resultado puede relacionarse con el Principio de ClasificaciA³n Efectiva de Mercados: las polA­ticas que se adopten deberAin asimilarse a aquellos objetivos sobre los que ejercen una influencia relativamente mayor. Si no se siguiera este principio, existirA­a la tendencia hacia un movimiento indirecto y aun inestable de las variables. El empleo de la polA­tica fiscal para fines externos y, de la polA­tica monetaria, para la estabilidad interna, infringe este principio, porque el efecto de las tasas de interA©s en el equilibrio interno, comparado con el que ejercen sobre la balanza de pagos, es menor que el efecto de la polA­tica fiscal sobre el equilibrio interno, comparado con el que ejerce sobre la balanza de pagos. Por razones anAilogas, la combinaciA³n alternativa de estas polA­ticas que se propone en las condiciones restrictivas aquA­ seA±aladas, armoniza con dicho principio. En un plano aAon mAis amplio estAi el principio de Tinbergen, que para lograr un nAomero dado de objetivos debe existir, al menos, un nAomero igual de instrumentos. El principio de Tinbergen se relaciona con la existencia y ubicaciA³n de una soluciA³n al sistema; no mantiene que un conjunto dado de medidas de polA­tica habrAi de conducir, de hecho, a dicha soluciA³n. Para hacer esta aseveraciA³n, es necesario investigar los atributos de estabilidad del sistema dinAimico. Es por esta razA³n que el Principio de ClasificaciA³n Efectiva de Mercados debe necesariamente acompaA±ar al principio de Tinbergen.

The Monetary Dynamics of International Adjustment under Fixed and Flexible Exchange Rates

Abstract: I. Introduction, 227. — II. The static system, 229. — III. The dynamic systems, 233. — IV. The crucial role of capital movements, 237. — V. Foreign exchange reserves, 242. — VI. Speculation, 246. — VII. Concluding remarks, 249. — Appendix, 251.

A Theory of Optimum Currency Areas

Abstract: It is patently obvious that periodic balance-of-payments crises will remain an integral feature of the international economic system as long as fixed exchange rates and rigid wage and price levels prevent the terms of trade from fulfilling a natural role in the adjustment process. It is, however, far easier to pose the problem and to criticize the alternatives than it is to offer constructive and feasible suggestions for the elimination of what has become an international disequilibrium system.' The present paper, unfortunately, illustrates that proposition by cautioning against the practicability, in certain cases, of the most plausible alternative: a system of national currencies connected by flexible exchange rates. A system of flexible exchange rates is usually presented, by its proponents,2 as a device whereby depreciation can take the place of unemployment when the external balance is in deficit, and appreciation can replace inflation when it is in surplus. But the question then arises whether all existing national currencies should be flexible. Should the Ghanian pound be freed to fluctuate against all currencies or ought the present sterling-area currencies remain pegged to the pound sterling? Or, supposing that the Common Market countries proceed with their plans for economic union, should these countries allow each national currency to fluctuate, or would a single currency area be preferable? The problem can be posed in a general and more revealing way by defining a currency area as a domain within which exchange rates are fixed and asking: What is the appropriate domain of a currency area? It might seem at first that the question is purely academic since it hardly appears within the realm of political feasibility that national currencies would ever be abandoned in favor of any other arrangement. To this, three answers can be given: (1) Certain parts of the world are undergoing processes of economic integration and disintegration, new experiments are being made, and a conception of what constitutes an optimum currency area can clarify the meaning of these experiments. (2) Those countries, like Canada, which have experimented with flexible exchange rates are likely to face particular problems which the theory of optimum currency areas can elucidate if the national currency area does not coincide with the optimum currency area. (3) The idea can be used to illustrate certain functions of currencies which have been inadequately treated in the economic literature and which are sometimes neglected in the consideration of problems of economic policy. A Theory of Optimum Currency Areas It is patently obvious that periodic balance-of-payments crises will remain an integral feature of the international economic system as long as fixed exchange rates and rigid wage and price levels prevent the terms of trade from fulfilling a natural role in the adjustment process. It is, however, far easier to pose the problem and to criticize the alternatives than it is to offer constructive and feasible suggestions for the elimination of what has become an international disequilibrium system.' The present paper, unfortunately, illustrates that proposition by cautioning against the practicability, in certain cases, of the most plausible alternative: a system of national currencies connected by flexible exchange rates. A system of flexible exchange rates is usually presented, by its proponents,2 as a device whereby depreciation can take the place of unemployment when the external balance is in deficit, and appreciation can replace inflation when it is in surplus. But the question then arises whether all existing national currencies should be flexible. Should the Ghanian pound be freed to fluctuate against all currencies or ought the present sterling-area currencies remain pegged to the pound sterling? Or, supposing that the Common Market countries proceed with their plans for economic union, should these countries allow each national currency to fluctuate, or would a single currency area be preferable? The problem can be posed in a general and more revealing way by defining a currency area as a domain within which exchange rates are fixed and asking: What is the appropriate domain of a currency area? It might seem at first that the question is purely academic since it hardly appears within the realm of political feasibility that national currencies would ever be abandoned in favor of any other arrangement. To this, three answers can be given: (1) Certain parts of the world are undergoing processes of economic integration and disintegration, new experiments are being made, and a conception of what constitutes an optimum currency area can clarify the meaning of these experiments. (2) Those countries, like Canada, which have experimented with flexible exchange rates are likely to face particular problems which the theory of optimum currency areas can elucidate if the national currency area does not coincide with the optimum currency area. (3) The idea can be used to illustrate certain functions of currencies which have been inadequately treated in the economic literature and which are sometimes neglected in the consideration of problems of economic policy.

The Endogeneity of the Optimum Currency Area Criteria

Abstract: A country's suitability for entry into a currency union depends on a number of economic conditions. These include, inter alia, the intensity of trade with other potential members of the currency union, and the extent to which domestic business cycles are correlated with those of the other countries. But international trade patterns and international business cycle correlations are endogenous. This paper develops and investigates the relationship between the two phenomena. Using thirty years of data for twenty industrialized countries, we uncover a strong and striking empirical finding: countries with closer trade links tend to have more tightly correlated business cycles. It follows that countries are more likely to satisfy the criteria for entry into a currency union after taking steps toward economic integration than before.

Optimum Currency Areas

Abstract: An optimum currency area refers to the ‘optimum’ geographical domain having as a general means of payments either a single common currency or several currencies whose exchange values are immutably pegged to one another with unlimited convertibility for both current and capital transactions, but whose exchange rates fluctuate in unison against the rest of the world. ‘Optimum’ is defined in terms of the macroeconomic goal of maintaining internal and external balance. Internal balance is achieved at the optimal trade-off point between inflation and unemployment (if such a trade-off really exists), and external balance involves both intra-area and inter-area balance of payments equilibrium.