optimum currency area

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.

This paper aims to provide a critical analysis of the evolution of the optimum currency area theory. The motivation for this paper arises from the fact that there are many studies that make references to the OCA theory, providing various insights for it. In the first part of the paper I will address the foundation of this theory through the contributions of Mundell (1961), McKinnon (1963), Kenen (1969) and the subsequent development, which has not been a smooth one. The contributions brought to the OCA theory have been market by some paradoxes, but there has been a reconciliation among those which led to a renewed interest into the subject. The second part refers to the empirical phase in which we focus mostly on the European integration experience due to the various data and research that it provides. Thus, there is a need to distinguish between the OCA theory and the EMU, the latter referring to a question regarding timing and modalities of creating a currency union. The merit of the OCA theory is that has brought together a large amount of research on monetary integration.

The optimum currency area (OCA) theory arises from the debates about the exchange rate regimes and adjustment under balance of payments disequilibria. Mundell (1961) in his seminal work on OCA theory challenged Friedman’s (1953) view on floating exchange rate regime as means to the adjustment under balance of payments disequilibria due to exogenous shocks. Mundell (1961) in his model of an asymmetric shift in demand of two countries stressed that optimum currency area can differ from the actual currency area. Such difference could cause inability of the floating exchange rate regime to cushion the shock and bring the countries back to equilibrium. That is why Mundell (1961) offered some non-exchange rates means for adjustment, as labor mobility, nominal flexibility and fiscal transfers. Later, Ingram (In: Kawai, 1987), McKinnon (1963) and Kenen (1969) extended the list of non-exchange rate means for adjustment by considering financial integration, openness and national product diversification. 1

Despite the importance of this initiative and steps already taken, and whereas the political will continues to gain momentum, there is concern that not enough empirical economic research has been done to buttress the initiative. This paper contributes to the existing meager empirical economic research about the viability of the EAC as a monetary union. The paper seeks to find out whether the EAC is an optimum currency area (OCA) by examining the synchronization of structural shocks of the member countries. Since countries in a monetary union employ a single monetary policy, it is important for the success of the union that member countries have synchronized business cycles. This assertion stems from the theory of optimum currency areas, whereby countries under a monetary union share a common monetary policy and therefore can not use national monetary or exchange rate policies to address country-specific shocks (Mundell, 1961 and McKinnon, 1963).

ASEAN5+3 tidak terlalu tinggi. Yang ada sebaliknya adalah guncangan simetris yang tinggi (Madhur, 2002). Pendeknya, dampak signifikan dan positif AS pada ERV menyarankan adanya sedikit perbedaan sekilas antara Singapura dan ekonomi ASEAN5+3nya. Pengamatan ini juga mengimplikasikan kebutuhan penyesuaian pada saat kondisi ekonomi partner dagang berubah secara tak terduga. Maka dari itu, kami dapat menyimpulkan bahwa negara-negara ASEAN5+3 tidak sesuai untuk membentuk sebuah serikat moneter dibawah konsep optimum currency area sehubungan dengan peleburan guncangan asimetris. Sama halnya dengan hasil tersebut telah mengindikasikan fakta bahwa kemungkinan terjadinya guncangan asimetri mengimplikasikan fluktuasi pada stabilitas mata uang di negara lain dalam regional. Maka dari itu, dampak positif AS terhadap ERV yang terjadi di ekonomi ASEAN5+3 mengindikasikan adanya kondisi yang tidak sesuai untuk membentuk OCA karena tidak ada guncangan yang sama antar negara serikat moneter. Dalam situasi seperti itu, ini akan menambah kerugian pembatalan nilai tukar sebagaimana guncangan mengganggu mekanisme.

In case of MERCOSUR we could barely fi nd a pair of countries with better values compare with euro area’s all-time average. It seems to be convenient for both Canada and Mexico to adopt a common currency with the USA. Most of indicators have improved in NAFTA, especially those between Mexico and Canada. Venezuela reaches the worst values in almost all indicators. The other countries reach better values, especially Argentina and Brazil. But we can say that the states of MERCOSUR are not appropriate candidates for creation of monetary union according to optimum currency area criteria which were approximated by OCA index in our paper.

278 According to Mundell (1961) and McKinnon (1963) -that are two seminal works on optimum currency area- the intensive for two economies to peg their bilateral exchange rate rise with the bilateral intensity of trade, flexibility of factor markets and symmetry of underlying shocks. However, it is generally accepted that the correlation of shocks is the most important criterion in a country’s decision to join a currency union (Huang and Guo, 2006). Mundell (1961) argued that countries facing positively correlated economic shocks (symmetric) will be better for making a currency union, because they would allow the use of the same policies to adjust any imbalances. Second we want to find the currency bloc which is more suitable for ASEAN+3 countries. Finally this paper will suggest a framework that the ASEAN+3 countries need to follow to extend the economic integration among them and make a monetary cooperation lead to a single common currency.

This paper is aiming to elaborate the case of how exchange rate volatility (ERV), which is supposedly considered to form optimum currency area (OCA), can be reduced in order justify the feasibility of the OCA idea within ASEAN5 plus three. Interestingly, the results provide some evidences that the ASEAN5+3 are considered not really ready to form OCA. It corroborates the existing opinion that the different in economic structure and its policies over foreign environment are becoming some barriers and challenging area to synchronize in the following time. The positive impacts AS to ERV which are incurred in ASEAN5+3 economies indicate the existence of inappropriate condition to form OCA since there are no similar shocks across a monetary union»s participating countries. Under such condition, it would foster the costs of forgoing the exchange rate as a shock absorbing mechanism. It deserves to argue that those observed countries still are resisting their existing regime since they are till believing that they begin to establish the system of monetary which are able to absorb any possible shocks in regards of their SIZE. In sum, the ASEAN5+3 countries are considered to fulfilling the requirement to form currency optimum area which are able to main their stable currency.

(especially in the RDLT model). Such high persistence spans from 4.3 to 16 years and is shown in Figure 5. As can be seen, real exchange rate persistence is even higher in Mercosur than in the usual findings of the PPP puzzle. Thus G-PPP does not hold for ‘full’ Mercosur. It is not an optimum currency area. This confirms previous suspicions (De Grauwe, 2005). Yet weakening the case for Mercosur does not strengthen the case for the FTAA because the Americas are also unlikely to constitute an optimum currency area (Karras, 2003).

The optimum currency area (OCA) theory tries to answer an almost prohibitively difficult question: what is the optimal number of currencies to be used in one region. The difficulty of the question leads to a low operational precision of OCA theory. Therefore, we argue that the OCA theory is a framework for discussion about monetary integration. We summarize theoretical issues from the classical contributions to the OCA literature in the 1960s to the modern “endogenous view”. A short survey of empirical studies on the OCA theory in the connection with the EMU and the Czech Republic is presented. Finally, we calculate OCA-indexes for the Czech Republic, EU, Germany and Portugal. The index predicts exchange rates variability from the view of traditional OCA criteria and asseses benefit-cost ratio of implementing common currency for a pair of the countries. We compare the structural similarity of the Czech Republic and Portugal to the German economy and find that the Czech economy is closer. The results are reversed when the EU economy is considered as a benchmark country.

This paper assesses the empirical desirability of the East Asian economies to an alternative exchange rate arrangement (a monetary union) that can potentially enhance the exchange rate stability and credibility in the region. Specifically, the symmetry in macroeconomic disturbances of the East Asian economies is examined as satisfying one of the preconditions for forming an Optimum Currency Area (OCA). We extend the existing literature by improving the methodology of assessing the symmetry shocks in evaluating the suitability of a common currency area in the East Asian economies employing the Bayesian State-Space Based approach. We consider a model of an economy in which the output is influenced by global, regional and country-specific shocks. The importance of a common regional shock would provide a case for a regional common currency. This model allows us to examine regional and country-specific cycles simultaneously with the world business cycle. The importance of the shocks decomposition is that studying a subset of countries can lead one to believe that observed co-movement is particular to that subset of countries when it in fact is common to a much larger group of countries. In addition, the understanding of the sources of international economic fluctuations is important for making policy decisions. Our findings also indicate that regional factors play a minor role in explaining output variation in the East Asian economies. Based on the insignificant share of regional common factor, our results imply that East Asia does not satisfy the OCA criteria.

The crisis resulted from a number of different factors whose relative weighting is controversial. Central reasons are substantially the unreasonable implementation of the fiscal rules (GDP) neither before nor during the crisis, in the Greek case with that inadequate and wrong statistical facts about the public finances (chart 12), the underestimation of fundamental structural deficits of several national economies, and since foundation of the EMU too optimistic assessments of the national budgets by the investors (Bundesbank, 2011, p. 66). Furthermore there is the specific constellation of the euro area with the not seriously taken assumption of the ‘no-bail-out‘ clause by the financial markets and the unique interest rate policy. Latter only enabled the economic overheating in the euro periphery countries (GCEE, 2010, p. 68-69). Moreover there was the faith of the ECB as ‘lender of last resort‘ and the unimaginable case of a state insolvency in the euro area (Sinn, 2012, p. 128).

The OCA theory has long existed in a vacuum in terms of the analytical tools needed to operate its theory. Mundell, McKinoon, and Kenen did not create a quantitative index for OCA, however, after 35 years, Bayoumi and Eichengreen (1997) constructed a procedure for computing OCA within an index. They applied a SD for the change in variability of exchange rates of two pairs of countries that were pegged to hard currencies. A smaller SD means greater opportunity to join the OCA and vice-versa. Besides the OCA-index, the Maastricht criteria have been used for estimating the readiness to join a currency union. These comprise four essential criteria: (1) An inflation rate of <1.5%, (2) interest rate below 2%, (3) fiscal deficit of <3% of GDP, and (4) the government debt should be a maximum of 60% of the GDP. Unfortunately, the Maastricht criteria are considered to be too tight and difficult to implement.

analysis, multiple window method using Slepian sequences, time-frequency varying autoregressive process estimation and time-frequency Fourier transform representation) to identify cyclical move- ments in the Euro area industrial production index. They found contrasting cyclical movements in the years 2007–2010, especially two significant shocks and effects in long-term cyclical movements. This shock caused that other cyclical movements in the time series were suppressed. Therefore, we sup- pose that the commonly used filtering techniques overestimate cyclical movements in the time series during the financial crisis and co-movements as well. Subsequently, the results of the analysis in the time-frequency domain may be significantly biased. The generally used methodological background in the time-frequency domain provides only the iden- tification of the significant symmetric shock in the years 2007–2010. The problem is in the trend elimi- nation. The standard filtering techniques identify financial crisis as the business cycle. To contribute to the recent methodology, we have to answer the key question, whether the financial crisis changed the business cycle frequency or not.

averages that are presented in Table 4. 9 The inflation pre-targeting sample unequivocally shows that a monetary union is feasible only between Canada and the US. Canada and Mexico react asymmetrically to US monetary policy shocks. The inflation targeting sample tells a different story, although the correlations are very weak and statistically insignificant: Canada and Mexico’s responses are similar, whilst Canada and the US are no longer suitable candidates. For the linkages between Mexico and the US, output responses are dissimilar but inflation responses are not. The two major shifts in policy that occurred in the 1990s may help explain the results of the inflation-targeting sample. During this time, Canada adopted domestic monetary policies that distanced its economy from the US, while Mexico embraced policies that brought its economy closer to the US. In the early 1990s, the Bank of Canada deviated drastically from US monetary policy by starting to target inflation and keep it within the range of 1–3%. As a result, a wide gap emerged between the two short-term interest rates, with severe consequences in terms of employment and output, which Fortin (1996) called “The Great Canadian Slump”. 10 Instead, Mexico adopted policies in 1989 to peg its currency to the US dollar, but suffered a setback in 1994 with the peso crisis and was forced to let its currency float freely. Since then, the Banco de México has implemented strategies to target inflation while the peso fluctuates in the foreign exchange market. When we take the average for the full sample period, we find that Canada and the US are suitable for a monetary union, Mexico and the US are not, and Canada’s and Mexico’s output responses to a US monetary policy shock are positively correlated but inflation responses are not. These findings are then compared with the average of the averages of the pre- and inflation-targeting period; we then realize that it is the pre-targeting sample results that dominate.

public balance and the effects of macroeconomic shocks on the current account of Germany were used and compared with those of other euro area and non-euro area countries. Compared to other countries in the region, there is an increase in the amount of savings, which they say is due to the fact that the German downturn and its impact on household savings have led to a decline in household consumption as a result of increased German income and output, as well as increased government spending and German GDP growth and current account surplus reduced, but its effects are poor. Jennifer and Kurt (2013) implemented and proposed stabilisation measures seek to remedy this vulnerability by promoting economic integration, further fiscal discipline and debt redemption [8]. Masini (2014) aims at investigating such relationships in a historical perspective, with a special reference to the evolving role of endogenous and exogenous criteria to the study of OCA. The historical reconstructions of the theories of Optimum Currency Areas (OCA) are usually biased by the underlying theoretical and policy orientation of their authors, they often provide a sort of internalize explanation of advancement in economic theory and sometimes neglect the influence of particular events and policy debates on the theoretical discussions [9]. Grauwe and Foresti, (2015) suggest that Eurozone countries face a policy trade-off among: 1) a common rule imposing co-movements in fiscal policy; 2) financial stability; and 3) financial integration. They provide empirical evidence documenting the existence of such a trade- off in the period characterized by the financial crisis and by the sovereign debt crisis. Then, they conclude that the intense fiscal rules that have been introduced in the Eurozone after the emergence of the debt

The second concerns the glut of foreign direct invest- ment. In reality, the volume and range of mobile real capital is large and wide. It is feared that the world as a whole may become a unique optimum currency area. Nevertheless, it is certain that such a tremendous and enlarged organization would never work well. It may be more practical to place a levy on international capital movement, like the Tobin tax.

There is a paucity of literature on business cycles synchronisation on various sub-Saharan African (SSA) regional blocs, perhaps due to the fact that SSA is characterised by wide macroeconomic economic differentials which makes its analysis difficult. Using cluster analysis [63] established that business cycles are more highly synchronized across the CFA France zone than across countries with sovereign currencies. In contrast, [64] tested the endogeneity of the Economic Community of Central African States (CEMAC) zone as an optimum currency area by examining the cross-country synchronization of their business cycles. His analysis concluded that the degree of synchronization of business cycles across CEMAC countries had remained low throughout the period 1960-2007, due to lower intra-regional trade and macroeconomic policies which do not converge.

Starting from the Optimum Currency Area (OCA), this paper utilize the Vector Error Correction Model (VECM) to identify the dynamic short term and the long term co-movement between the ASEAN 4 currencies, including their existing fundamental mechanism. There are at least 3 important findings, (i) the co-movement between the ASEAN 4 currencies is not proved empirically, (ii) the theory of OCA does not robust in explaining the co-movement pattern in ASEAN, and (iii) the existance of OCA is a global phenomena, indicated from the significance of Yen currency on the ASEAN 4. These findings led to a conclusion of this paper that the ongoing economic integration as well as the financial one in ASEAN are not enough to form a unified monetary arrangement nor a common currency in this region.

Countries sharing the same currency but with asymmetric business cycles will incur costs associated with the monetary authority making decisions which benefit not all countries within the monetary union. If one country in a monetary union is undergoing an expansion while another one is in a recession, a restrictive monetary policy will benefit the booming economy but exacerbate the problems of the depressed one. The area of focus in this respect has usually been the euro area, with the optimality of the U.S. as a single currency area a foregone conclusion. This paper will however take a closer look at the U.S. and see just how the individual states' business cycles are similar to the aggregate U.S. business cycle. If there are states that are out of sync with the national business cycle, then that might indicate that those states are subjected to monetary policy that doesn't suit them. Thus on at least one dimension, business cycle similarity, the asynchronous states will deviate from the optimum currency area ideal. To study this issue, we rely on wavelet based measure of business cycle synchronization. Wavelet analysis is particularly well-suited to study business cycle synchronization. This is so, because with wavelets one can estimate the spectral characteristics of a time-series as a function of time, revealing how the different periodic components of a particular time-series evolve over time. Rua (2010) was probably the first author to rely on wavelet analysis to measure comovements between different regions in the time-frequency space. We will follow the procedure proposed by Aguiar-Conraria and Soares (2011) ― also applied by Aguiar-Conraria, Martins and Soares (2013) and Aguiar-Conraria, Magalhães and Soares (2013) ― to compare the wavelet spectra of two regions. By doing so, we test if the contribution of cycles at each frequency is similar, if this contribution happens at the same time or not, and, finally, if the ups and downs of each cycle occur simultaneously.