European Economic and Monetary Union (EMU) Definition, Optimum Currency Area (OCA) Theory Definition. And he This paper explains that selecting the optimal geographic area for a single currency involves balancing two considerations. stable url 4 (Sep., 1961), pp. Optimum Currency Areas. Mundell, Robert (1961) A theory of optimum currency areas. “The question Mundell posed in his article on “optimum currency areas” (1961) therefore seemed radical: when is it advantageous for a number of regions to relinquish their monetary sovereignty in favor of a common currency?” Macroeconomic stability is enhanced if the currency area has a high degree of internal factor mobility relative to the cross-border factor mobility. By using Investopedia, you accept our. The following points highlight the top five contributions of Robert A. Mundell to Economics. Critics argue that the EMU did not adequately provide for the greater economic and fiscal integration necessary for cross-border risk-sharing. currency area of either type cannot prevent both unemployment and inflation among its members. Note that this criteria can come into conflict with some of the above criteria, because the greater the degree of integration among countries' economies (mobility of goods, labor, and capital) the more they will tend to specialize in different industries. In this model, the primary concern is that asymmetric shocks may undermine the benefit of the OCA. From his theory of optimum currency areas published in 1961, Mundell seemed to be arguing in favor of making currency … A Conference on Optimum Currency Areas at Tel-Aviv University, 5th December 1997. American Economic Review. However, a common currency results in a loss of each country's ability to direct fiscal and monetary policy interventions to stabilize their individual economies. The theory of optimum currency areas (OCA) explores the criteria as well as first time that someone used the phrase optimum currency area was Mundell. On the one hand, optimum currency areas would, in any case, almost never fit into the confines of a state or a collection of existing states. 1961. While traditionally each country has maintained its own separate, national currency, work by Robert Mundell in the 1960s theorized that this might not be the most efficient economic arrangement. Get smart with the Thesis WordPress Theme from DIYthemes. Optimum Currency Areas and Key Currencies: Mundell I versus Mundell II. Robert Mundell's Work on Optimum Currency Areas Don Roper The 1999 Nobel Prize in Economics was given to Robert Mundell, in part for his work, Optimum Currency Areas, which is often credited with the development of the Euro. The diminution of A national currency however, was considered an axiom. In particular, countries that share strong economic ties may benefit from a common currency. In 1961 Robert Mundell published his famous article A Theory of Optimum Currency Are-as1 presenting his idea of an optimal mone-tary area in which there should be perfect in- ... optimal currency area (OCA) criteria in the light of EMU, Working Paper 69, Wien: Österreichische 510-11] True, Mundell carefully hedged his argument by giving examples of countries which were not optimum currency areas—as when the main terms of trade shocks occurred across regions within a single country—rather than between countries. Overall, this episode implies that due to the asymmetry of the economic shock to Greece relative to other countries in the EMU and apparent shortfalls in the EMU’s qualification as an OCA under Mundell’s criteria, that Greece (and perhaps other countries) might not actually fall within the OCA for the euro. The Optimum Currency Area Theory and the Euro Robert A. Mundell Global Risk Annual Lecture as part of the Global Risk Series With his careful analysis of Optimum Currency Area (OCA) theory and its application in the Eurozone, Professor Vitor Constancio, former Vice President of the European Central Bank (2010-2018), pays Some sectors in the OCA might end up becoming concentrated in a few locations. Robert Mundell laid the theoretical foundations for the European Monetary Union. As Greece’s sovereign debt crisis continued to worsen, there was discussion suggesting that the EMU must account for risk-sharing policies far more extensive than the current provisionary bailout system. Ronald I. McKinnon. The original OCA theory. The theory of the optimal currency area was pioneered by economist Robert Mundell. by Mundell (1961), McKinnon (1963a), and Kenen (1969) employ this approach. In 1961, Canadian economist Robert Mundell published his theory of the optimal currency area (OCA) with stationary expectations. Downloadable! The theory of optimum currency areas, initiated by Robert Mundell (1961), is the organizing framework for the analysis. Three of Mundell’s achievements are particularly worthy of note. May 2000 Robert Mundell seems to be on both sides of the debate over European monetary unification and on the adoption of common monetary standards in other parts of the world. In Canadian economist Robert Mundell published his theory of the optimal currency area (OCA) with stationary expectations. “The question Mundell posed in his article on “optimum currency areas” (1961) therefore seemed radical: when is it advantageous for a number of regions to relinquish their monetary sovereignty in favor of … Indeed, recent interest in optimum currency areas has been revived by the proposal for a common Euro- His theory of optimum currency areas, highlighted in the Nobel Committee’s munsell as one of his most significant scientific contributions, has served since the s as an analytical framework for numerous debates on the validity of the creation of a European currency. This spreads the shocks in the area because all regions share claims on each other z the same currency and can use them for dampening the shock, while in a flexible exchange rate regime, the cost will be concentrated on the individual regions, since the devaluation will reduce its buying power. Click to share on Facebook (Opens in new window), Click to share on Twitter (Opens in new window), Click to email this to a friend (Opens in new window), Click to share on Reddit (Opens in new window), Emerging Markets and Transition Economies, History of the International Monetary System. Consider a number of countries, and call them a region. The Works of Robert Mundell. A Theory of Optimum Currency Areas (1961), by Robert Mundell, was selected for the Top 20. 51, No. The euro raises issues addressed by a theory known as the optimum currency area (OCA) theory. However, in practice this was abandoned early on in the sovereign debt crisis. ‘‘Theory of Optimum Currency Areas.’’ American Economic Review 51: 657–65. The theory of the optimal currency area was pioneered by economist Robert Mundell. At that time there was not much enthusiasm for a European currency, but by the late 1960s things had changed. optimum currency area (OCA) theory Optimum currency area (OCA) theory originates from two seminal articles in the early 1960s by the ... Mundell, Robert. Economist Robert Mundell first outlined criteria for an OCA, which are based on the degree of integration and similarity between economies. Robert Mundell ‘A Theory of Optimum Currency Areas’, 1961 ‘Uncommon Arguments for Common Currencies’ p. 115, 1973. Post was not sent - check your email addresses! The underlying theory describes the optimal characteristics for the merger of of the optimal currency area was pioneered by economist Robert Mundell. An optimal currency area (OCA) is the geographic area in which a single currency would create the greatest economic benefit. The fault lies not with the type of currency area but with the domain of the currency area. Homogeneous policy preferences across countries in the OCA are important because monetary policy, and to some extent fiscal policy in the form of transfers, will be a collective decision and responsibility of the countries in the OCA. May 2000 Robert Mundell seems to be on both sides of the debate over European monetary unification and on the adoption of common monetary standards in other parts of the world. 51:11, 509-517. According to Mundell, there are four main criteria for an optimal currency area: Other criteria have been suggested by later economic research: The optimal currency area (OCA) theory had its primary test with the introduction of the euro as a common currency across European nations. Technically, the European Stability and Growth Pact included a “no-bailout” clause that specifically restricted fiscal transfers. The euro is an example of an application of an OCA, though events such as the Greek debt crisis have put this to the test. He received the Nobel Memorial Prize in Economic Sciences in 1999 for his pioneering work in monetary dynamics and optimum currency areas. 657-665 Understanding Optimum Currency Area (OCA) Theory Optimum currency area theory (OCA) was developed in 1961 by Canadian economist Robert Mundell based on earlier work by Abba Lerner. Thus, the long-term outcome of a monetary union under the theory of optimal currency areas remains a subject of debate. In his 1961 article on optimum currency areas, Mundell radically reformulated the problem of different exchange rate systems, by posing a new and fundamental question: Under what circumstances is it advantageous for a number of regions to relinquish their monetary sovereignty in favor of a common currency? Investopedia uses cookies to provide you with a great user experience. The "optimum" currency area is not the world. An optimal currency area (OCA) is the geopolitical area over which a single, unified currency will provide the best balance of economies of scale to a currency and effectiveness of macroeconomic policy to promote growth and stability. Een optimaal valutagebied (Engels: optimum currency area; verkort OCA) is een concept uit de economie, waarmee een geografische regio wordt aangeduid waarvan de economische efficiëntie gemaximaliseerd zou kunnen worden door de invoering van één munteenheid. He single-handedly invented the concept of an optimum currency area, perhaps 1 This paper is a revision of an earlier paper which evaluated the economic contr ibutions of Robert Mundell. At the time, a few researchers did address the advantages and disadvantages of fixed versus floating exchange rates, even though this was regarded as rather academic subject matter. High labor mobility throughout the area. Countries that are heavily specialized in certain goods that other countries do not produce will be vulnerable to asymmetric economic shocks in those industries, and might not be suitable for membership in the OCA. The European Economic and Monetary Union (EMU) refers to all of the countries that have adopted a free trade an monetary agreement in the Eurozone. The Maastricht Treaty was a treaty that is responsible for the creation of the European Union and was approved by heads of government of the states making up the European Community (EC) in December 1991. But this paradox can be resolved by noting that there are two Mundell models-earlier and later. The offers that appear in this table are from partnerships from which Investopedia receives compensation. theory of optimum currency areas robert mundell the american economic review, volume 51, issue (sep., 1961), 657—665. If specialization increases, each country will be less diversified and will face more asymmetric shocks; weakening the … The question is innovative, for Mundell envisaged a new global monetary map from the regional rather than the national viewpoint. But this paradox can be resolved by noting that there are two Mundell models-earlier and later. I thank Rich Lyons and Janet Yellen for comments. The eurozone is a geographic area that consists of the European Union (EU) countries that have fully incorporated the euro as their national currency. ... determining an optimum currency area has direct relevance to inter-national monetary arrangements. This paper explains that selecting the optimal geographic area for a … On April 4, 2002, Nobel Laureate in Economics Robert Mundell, currently University Professor Emeritus at Columbia University, delivered the Sir John A. Macdonald… Robert Mundell Lecture: "Is North America an Optimum Currency Area?" Easing labor mobility includes lowering administrative barriers such as visa-free travel, cultural barriers such as different languages, and institutional barriers such as restrictions on remittance of. Fiscal imbalance is a situation in which the future incomes streams for unit of government do not balance the future debt and spending obligations. The theory of optimum currency areas (OCA) explores the criteria as well as first time that someone used the phrase optimum currency area was Mundell. Subsequent to the rise of the EMU and the adoption of the euro by participating European countries in 2002, the European sovereign debt crisis in the wake of the Great Recession is cited as evidence that the EMU did not fit the criteria for a successful OCA. Of course, the European common currency didn’t happen overnight. In this theory, if large asymmetric shocks are common and the criteria for an OCA are not met, then a system of separate currencies with floating exchange rates would be more suitable in order to deal with the negative effects of such shocks within the single country experiencing them. Nobel Prize Press Release. Fixed exchange rates within the framework of the Bretton Woods system predominated the world economy in the early1960s. Eurozone countries matched some of Mundell's criteria for successful monetary union, providing the impetus for the introduction of a common currency. He outlined the criteria necessary for a region to qualify as an optimal currency area and benefit from a common currency. More diversified production within economies and limited specialization and division of labor across countries reduce the likelihood of asymmetric economic shocks. This allows for closer integration of capital markets and facilitates trade. In my booklet Mundell (1965), I analyzed a model of three currency areas--the dollar area, the sterling area, and a third bloc based on a European currency, what I called the Athaler@ area. Optimality is here defined in terms of the ability to stabilize national employment and price levels. Major differences in local preferences for how to respond to either symmetric or asymmetric shocks can undermine cooperation and political will to join or remain in the OCA. [Robert Mundell, 1961. pp. American Economic Association A Theory of Optimum Currency Areas Author(s): Robert A. Mundell Source: The American Economic Review, Vol. In Mundell’s paradigm, policymakers balance the saving in transactions costs from the creation of a single money against the consequences of diminished policy autonomy. Starting in the 1950s, European countries went through various stages of economic and monetary integration. 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