A Model of an Optimum Currency Area

IMF Working Papers, June 1, 1997

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A Model of an Optimum Currency Area

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Bibliographic details

• Authors: Luca A Ricci
• Published: June 1, 1997
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781451849837.001

Summary

• Title: A Model of an Optimum Currency Area
• Author: Luca A Ricci
• Publication date: June 1, 1997
• Type: IMF Working Paper (Working Paper No. 1997/076)
• Core question: Investigates the circumstances under which it is beneficial to participate in a currency area.

Model and mechanisms analyzed

• Framework: A two-country monetary model of trade with nominal rigidities.
• The model encompasses the real and monetary arguments from the optimum currency area literature, specifically:
  • correlation of real shocks
  • international factor mobility
  • fiscal adjustment
  • openness
  • difference in national inflationary biases
  • correlation of monetary shocks
  • benefits of a single currency

Key findings

• The effect of openness on net benefits is ambiguous, contrary to the usual argument that more open economies are better candidates for a currency area.
• Countries do not necessarily agree on whether a given currency union should be created.
• The paper integrates both real and monetary considerations in assessing net benefits of currency union participation.

Policy implications and interpretation

• Cost-benefit analysis of joining a currency union must account simultaneously for:
  • real shock correlations and their cross-country covariance
  • international factor mobility (including labor mobility)
  • fiscal adjustment capacities and redistribution properties
  • monetary biases and the correlation of monetary policy shocks
  • potential benefits from adopting a single currency
• Openness should not be treated as a unambiguous criterion favoring currency union membership; policy conclusions about optimal membership depend on the full set of model parameters and the relative weight of the listed mechanisms.
• Because countries may reach different assessments of net benefits, voluntary agreement on creating a currency union cannot be assumed.

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