Optimum Currency Areas: The Challenge for Policy

• Author: David Cheney
• Position: Editor, IMF Survey
• Pages: 14-16

Page 14

IMF officials, central bankers, and academics gathered in Tel Aviv in early December 1996 to discuss issues of international monetary and fiscal integration relevant for European Union (EU) members on the threshold of monetary union. The conference was dedicated to Robert Mundell, who pioneered the theory of optimum currency areas (OCA) back in 1961 while on the research staff of the IMF. It was organized by Mario I. Blejer of the IMF's Monetary and Exchange Affairs Department and Assaf Razin of Tel Aviv University and hosted by the IMF, the Bank of Israel, and Tel Aviv and Hebrew Universities.

In his trailblazing paper, Mundell said that "if the world could be divided into regions, within each of which there is factor mobility and between which there is factor immobility, then each of these regions should have a separate currency which fluctuates relative to all other currencies." A region adopting a common currency would do so where costs are minimized and benefits maximized. The costs entail the loss of an independent monetary policy and exchange rate to cushion shocks, while the benefits include reduced transactions costs, greater efficiency associated with integration of markets, and anchoring of prices in a larger monetary area. Mundell said that whether or not Europe could be considered a single region-and hence a candidate for an OCA-was essentially an empirical question. His theory was extended by Ronald McKinnon (in 1964) and Peter Kenen (in 1969), but these pioneering analyses offered little empirical evidence. Given the prospective European economic and monetary union (EMU), the pace of empirical work on OCAs has stepped up considerably to shed more light on EMU's potential costs and benefits.

The Tel Aviv conference thus focused on various empirical aspects of OCAs, assessing prospects for EMU by 1999. At a luncheon address, Robert Mundell, noting that developments in the past year and a half had boosted the chances of monetary union, speculated that by 1999, all 15 countries of the EU might participate. Several participants took a different view. They agreed that political momentum and economic developments had recently improved prospects for monetary union, but debated the costs and benefits-and its implications for fiscal policy. Martin Wolf of the Financial Times, for example, thought that a 15-member EMU would fail and leave in its wake an inner...