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Is Euro Area an Optimal Currency Area and What Barriers Could Obstruct Its Future Development

01 Jan 2013-ACTA VŠFS (University of Finance and Administration)-Vol. 7, Iss: 2, pp 123-144
TL;DR: In this article, the Optimal Currency Area model (OCA) was used to evaluate the Eurozone and European monetary integration process and the findings showed that the euro area does not exactly meet majority of criteria for OCA model but due to strong political will of European states is the euro project going to continue.
Abstract: European monetary integration has been a really ambitious project since the very beginning and during last decade it succeeded in many areas. The euro was launched without serious problems and since then the European Central Bank has managed to achieve a low inflation rate in the whole euro area. The European Union and the euro experienced the world economic crisis in 2008 and dealing with the impacts of this crisis was a real challenge for the EU, for all the member states, single monetary policy and the euro area and also for the whole integration process. In our paper we will proceed from the Optimal Currency Area model (OCA, developed by Robert A. Mundell, Peter Kenen and Ronald McKinnon) to conditions of the euro area and European currency integration process. The paper will summarize the OCA model and test the criteria for OCA in European conditions and identify barriers to the OCA as imperfect mobility of the labour market, an unfinished single market, insufficient coordination and cooperation in common macroeconomic areas within the euro area, asymmetric shocks and others. The findings will show us that euro area does not exactly meet majority of criteria for OCA model but due to strong political will of European states is the euro project going to continue. This paper also discuss the perspectives of European monetary integration.
Citations
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Posted Content
TL;DR: In this article, the authors present an empirical assessment of wage inertia based on new econometric estimates of a Phillips-curve type wage equation across euro area countries and offer an interpretation of the main findings with respect to nominal and real wage flexibility.
Abstract: Both common macroeconomic shocks and country-specific developments have subjected the flexibility of wage setting mechanisms in the euro area to a stress test in recent years. Against this background, this paper takes a fresh look at wage flexibility in EMU and attempts to draw a few lessons from the experience of the early years. First, we set the stage for the analysis by providing a brief description of the stylised facts regarding nominal and real wage and unit labour cost developments in the euro area over the recent business cycle. Then, the paper presents an empirical assessment of wage inertia based on new econometric estimates of a Phillips-curve type wage equation across euro area countries and offers an interpretation of the main findings with respect to nominal and real wage flexibility. Finally, we investigate the cyclical responsiveness of relative competitive positions among euro area countries. We conclude that from a bird's eye perspective euro area wage and labour cost dynamics have been quite benign in the past couple of years. However, our estimates suggest that persistent cross-country differences in wage and labour cost developments have not always reflected warranted adjustment needs; they are rather indicative of an eventually insufficient degree of nominal and real wage flexibility in the euro area.

57 citations

Dissertation
01 Apr 2015
TL;DR: In this article, a comparison of different estimation methods applied in the gravity model literature is employed to investigate this effect and to identify the factors affecting trade in the transport equipment manufacturing sector, and the results demonstrate that the single currencys effect on trade in this sector is limited with only the fixed effects formulation with year dummy variables showing a significant positive effect of the euro.
Abstract: The introduction of the single currency (Euro) in Europe has been referred to as the ˜worlds largest economic experiment and has led to major research on the effects of the adoption of a common currency on economic activity with considerable emphasis on its effect on trade flows at the macroeconomic level. However, the investigation of the euro effect on individual sectors has received very little attention and this provides the motivation for the research. The main contribution of this thesis is to the sectoral analysis of the single currencys effect on bi-lateral trade flows, specifically the effects on the transport equipment manufacturing sector. In order to achieve this, a comparison of the different estimation methods applied in the gravity model literature will be employed to investigate this effect and to identify the factors affecting trade in this sector. This study uses a panel data set which comprises the most recent information on bilateral trade for the EU15 countries from 1990 to 2008. This research aims to build on the results obtained in previous studies by employing a more refined empirical methodology and associated tests. The purpose of the tests is to ensure that the euros effect on trade is isolated from the other pro- trade policies of the European integration processes, particularly the introduction of the Single Market. The desirable feature of this approach is that, while other studies limit their attention to a particular issue (zero trade flow, time trend, sectoral analysis, cross-correlation, etc.), very few, if any, apply a selection of techniques. Overall, the results demonstrate that the single currencys effect on trade in this sector is limited with only the fixed effects formulation with year dummy variables showing a significant positive effect of the euro. An obvious policy implication for countries looking to adopt a single currency is that they should be cautious regarding the potential for growth in intra-bloc trade in a particular sector, although they will benefit from the on-going process of integration.

4 citations

Posted Content
TL;DR: Although analyzed in terms of criteria for defining an optimum currency area, we could appreciate that EU fulfils certain criteria established within the theory of the optimal currency area But in comparison with USA or Canada, the EU has less premises to effectively become such an area.
Abstract: Although analyzed in terms of criteria for defining an optimum currency area, we could appreciate that EU fulfils certain criteria established within the theory of the optimum currency area But in comparison with USA or Canada, the EU has less premises to effectively become such an area The Economic and Monetary Union considered, from a certain point of view, the most ambitious and risky project of the European construction, is the result of a fundamental political decision within a powerful economic component Despite the statute of sub-optimum currency area, there are still a series of arguments, both supportive and critical, for the settlement of an Economic and Monetary Union within the European space

4 citations

Journal ArticleDOI
01 Jan 2020
TL;DR: In this article, the authors deal with the reconsideration of crucial Optimum Currency Area (OCA) criteria observing Eurozone (EZ) members in the period 2007-2018.
Abstract: This paper deals with the reconsideration of crucial Optimum Currency Area (OCA) criteria observing Eurozone (EZ) members in the period 2007-2018. According the aim to highlight key obstacles to EZ optimality, economies are mainly grouped into the core and peripheral countries of the initial 12 EZ members (EZ12), and subsequently joined 7 Emerging European Economies (EZ19). The research is based on descriptive analysis of openness and production diversification, macroeconomic divergences and heterogeneity of EZ members, labor mobility and wage flexibility, as well as political OCA criteria. While EZ was not initially constituted as an OCA, this research has confirmed persistent difficulties in EZ functioning in the (post) crisis period. Macroeconomic divergences between member states, insufficient labor mobility and wage flexibility, as well as the absence of political will towards creation of more efficient fiscal union, are identified as the main challenges of EZ sustainability.

4 citations

Journal ArticleDOI
TL;DR: In this article, the authors explored the Euro-zone monetary transmission via estimated vector autoregression (VAR) model for the representatives of the core (Germany, France, Belgium, as well as the periphery (Portugal, Spain and Greece), in the period 1999Q1-2018Q4.
Abstract: The paper deals with the nominal and real divergences within the Euro-zone (EZ) as a background for asymmetric European Central Bank’s (ECB’s) monetary transmission. In order to shed more light into these issues, the descriptive analysis of key nominal and real indicators confirms the core-periphery dichotomy within original EZ12 members, as well as the specific position of the emerging EZ19 members. Monetary (interest rate) transmission is explored via estimated Vector Autoregression (VAR) model for the representatives of the core (Germany, France, Belgium), as well as the periphery (Portugal, Spain and Greece), in the period 1999Q1-2018Q4. Observing the transmission of ECB’s interest rate (the shock) to gross domestic product (GDP) growth (the response), the results of variance decompositions and impulse responses indicate that interest rate channel works countercyclical in general. However, while stabilizing (countercyclical) effect is evident for the core (especially Germany), it is almost absent in the case of Greece. The conclusions highlight the vulnerability of the EZ in the sense of heterogeneous membership and, accordingly, asymmetric response to ECB’s monetary impulse. Our findings support the arguments of numerous research papers in emphasizing core-periphery dualism, German dominance hypothesis, and “one size fits some” monetary policy.

1 citations


Additional excerpts

  • ...Although Europe was seen as an ideal candidate for testing Mundell’s OCA theory, some economists were aware of divergent economies in economic reality that impede the functioning of European monetary union....

    [...]

  • ...Markets were "blind" to whether the EZ was truly an OCA due to the prevailing assumption that a common currency entails shared risk....

    [...]

  • ...If criteria for optimum currency area (OCA) are fulfilled (Mundell, 1961) the need for national monetary policy is mitigated making thus monetary union more sustainable (Rose, 2008)....

    [...]

  • ...However, EZ is not created as an OCA (Vrňáková & Bartuńková, 2013; Koziara, 2016)....

    [...]

  • ...OCA theory stresses the degree to which real convergence is sufficient to allow economies to function synchronously within the EZ in order to reduce the risk of asymmetric shocks (Auf dem Brinke, Enderlein, & Fritz-Vannahme, 2015; Franks et al., 2018)....

    [...]

References
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01 Jan 1961
TL;DR: A theory of optimum currency areas is proposed in this paper, where the authors argue 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.
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.

4,673 citations

Book
01 Jan 1953
TL;DR: In this paper, Newman's critical blast blows like a north wind against the more pretentious erections of modern economics, however a healthy and invigorating blast, without malice and with a sincere regard for scientific objectivity.
Abstract: "Stimulating, provocative, often infuriating, but well worth reading." Peter Newman, "Economica" "His critical blast blows like a north wind against the more pretentious erections of modern economics. It is however a healthy and invigorating blast, without malice and with a sincere regard for scientific objectivity." K.E. Boulding, "Political Science Quarterly" "Certainly one of the most engrossing volumes that has appeared recently in economic theory." William J. Baumol, "Review of Economics and Statistics""

3,029 citations

Posted Content
TL;DR: The authors investigated the relationship between international trade patterns and international business cycle correlations and found that countries with closer trade links tend to have more tightly correlated business cycles and were more likely to satisfy the criteria for entry into a currency union after taking steps toward economic integration than before.
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.

2,675 citations

Posted Content
TL;DR: In this paper, a survey of the optimum currency area (OCA) literature is presented, which is organized into four phases: the "pioneering phase" which put forward the OCA theory and its properties, the "reconciliation phase" when its diverse facets were combined, the ''reassessment phase'' that led to the ''new OCA'' theory, and the ''empirical phase'' during which the theory was subject to due empirical scrutiny.
Abstract: This paper surveys the optimum currency area (OCA) literature. It is organised into four phases: the "pioneering phase" which put forward the OCA theory and its properties, the "reconciliation phase" when its diverse facets were combined, the "reassessment phase" that led to the "new OCA theory", and the "empirical phase" during which the theory was subject to due empirical scrutiny. We make systematic reference to the European economic and monetary union (EMU) to which the OCA theory has been most frequently applied. All pioneering contributions are still relevant. Several early weaknesses have now been amended. Meanwhile, the balance of judgements has shifted in favour of currency unions. They are now deemed to generate fewer costs in terms of the loss of autonomy of domestic macroeconomic policies, and there is greater emphasis on the benefits. Looking ahead we are confronted with two distinct paradigms - specialisation versus "endogeneity of OCA".

424 citations

Book
30 Nov 2003
TL;DR: In this article, the authors present a history, facts and institutions of the European Monetary Union (EMU) and the Eurozone in crisis, as well as a discussion of the economic integration of the EMU.
Abstract: Part 1: History, Facts and Institutions 1. History 2. Facts, Law, Institutions and Budget 3. Decision Making Part II: The Microeconomics of Economic Integration 4. Essential Microeconomics Tools 5. The Essential Economics of Preferential Liberalization 6. Market Size and Scale Effects 7. Growth Effects and Factor Market Integration 8. Economic Integrations, Labour Markets and Migration Part III: EU Micro Policies 9. The Common Agricultural Policy 10. Location Effects, Economic Geography and Regional Policy 11. EU Competition and State Aid Policy 12. EU Trade Policy Part IV: The Macroeconomics of Monetary Integration 13. Essential Macroeconomic Tools 14. Essential Facts of Monetary Integration 15. Optimum Currency Areas Part V: EU Monetary and Fiscal Policies 16. The European Monetary Union 17. Fiscal Policy and the Stability Pact 18. The Financial Markets and the Euro 19. The Eurozone in crisis

390 citations