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The Optimum Currency Area Theory and the EMU: an Assessment in the Context of the Eurozone Crisis A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Jager, Jennifer; Hafner, Kurt A. Article — Published Version The optimum currency area theory and the EMU: An assessment in the context of the eurozone crisis Intereconomics Suggested Citation: Jager, Jennifer; Hafner, Kurt A. (2013) : The optimum currency area theory and the EMU: An assessment in the context of the eurozone crisis, Intereconomics, ISSN 1613-964X, Springer, Heidelberg, Vol. 48, Iss. 5, pp. 315-322, http://dx.doi.org/10.1007/s10272-013-0474-7 This Version is available at: http://hdl.handle.net/10419/126400 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. www.econstor.eu DOI: 10.1007/s10272-013-0474-7 Optimum Currency Area Jennifer Jager and Kurt A. Hafner The Optimum Currency Area Theory and the EMU An Assessment in the Context of the Eurozone Crisis The eurozone crisis has revealed certain shortcomings of the EMU, such as its vulnerability to asymmetric shocks and its inability to act as predicted by the theory of optimum currency areas. Although the share of intra-EU trade has increased since the introduction of the euro, dissimilarities in economic structure combined with high degrees of industrial specialisation have increased the EMU’s vulnerability to asymmetric shocks. Moreover, the lack of labour mobility or a transfer payment system limits the EMU’s crisis adjustment capabilities. However, most of the implemented and proposed stabilisation measures seek to remedy this vulnerability by promoting economic integration, further fi scal discipline and debt redemption. When 11 European countries abandoned their national cur- eurozone crisis are also suitable to improve the EMU’s perfor- rencies and formed the Economic and Monetary Union (EMU) mance as a currency union in the long run. in 1999, European leaders hoped that the common currency would boost economic integration among member countries. Below, we discuss the theory of optimum currency areas be- More than ten years after the creation of the common curren- fore evaluating the EMU with respect to the fulfi lment of the cy area, the eurozone crisis has put the euro under massive OCA criteria. We then examine stabilisation measures, three pressure and raised questions on whether the initial goals of of which have already been implemented and two of which are the common currency were overly optimistic. The euro turned still in the proposal stage, regarding their impact on the EMU out to be a heavy burden for some periphery countries when as a currency union. We conclude with a summary of the main the monetary union was hit by an asymmetric shock, i.e. the fi ndings. fi nancial crisis of 2007-08. It appears that European countries were insuffi ciently integrated to join a common currency, as The theory of optimum currency areas predicted by Mundell’s theory of optimum currency areas (OCA).1 In the wake of the eurozone crisis, the implications of The theory of optimum currency areas pioneered by Mun- the OCA theory have therefore regained relevance. dell was further complemented by McKinnon and again by Kenen.2 The theory addresses the question of under which This paper discusses the performance of the EMU as a cur- circumstances a country benefi ts from membership in a cur- rency union in the context of the eurozone crisis and analy- rency union. According to the OCA theory, a country that con- ses the impact of several stabilisation measures on the euro siders membership in a currency union has to balance the area. The eurozone crisis revealed several shortcomings of economic stability loss (i.e. losing national monetary policy) the EMU, such as its vulnerability to asymmetric shocks and against the monetary effi ciency gain (i.e. a competitiveness its inability to act decisively. We therefore aim to analyse the gain due to a decline in the general price level, stimulated ag- EMU in respect to the fulfi lment of the OCA criteria in order gregate demand and enhanced exports) of a single currency. to fi nd out where the main weaknesses lie. Moreover, we will Baldwin and Wyplosz stress that the loss of economic mon- investigate whether the implemented and proposed stabilisa- etary policy sovereignty becomes most signifi cant for mem- tion measures that are primarily designed to overcome the bers of a currency union if poorly integrated member countries face asymmetric macroeconomic shocks.3 In particular, an 1 R.A. Mundell: A Theory of Optimum Currency Areas, in: American economic shock is considered to be asymmetric if only one Economic Review, Vol. 51, No. 4, 1961, pp. 657-665. part of the currency union is hit by the shock while the other 2 R.I. McKinnon: Optimum Currency Areas, in: American Economic Review, Vol. 53, No. 4, 1963, pp. 717-725; P.B. Kenen: The Theory Jennifer Jager, Heilbronn University, Germany. of Optimum Currency Areas: An Eclectic View, in: R.A. Mundell, A. Swoboda (eds.): Monetary Problems of the International Economy, Chicago 1969, University of Chicago Press, pp. 41-60. Kurt A. Hafner, Heilbronn University, Germany. 3 R.E. Baldwin, C. Wyplosz: The economics of European integra- tion, 2nd ed., London 2006, McGraw-Hill Education. ZBW – Leibniz Information Centre for Economics 315 Optimum Currency Area part is spared or if member countries differ widely in terms of Turning to the second group of OCA criteria, the homogeneity the shock’s impact on their economies. Hence, if some coun- of preferences is considered an essential prerequisite in order tries in a currency union experience a positive (negative) de- to guarantee effi cient crisis management. As monetary policy mand shock, this would lead to disequilibrium, as output and is transferred to a supranational level, a consensus on the way prices in those countries would be too high (low). The union’s to deal with asymmetric shocks becomes a necessary condi- common central bank could then increase its money supply tion for monetary policy that serves as a one-size-fi ts-all ap- and help countries to recover economic strength, but only at proach for the entire currency union. Factor mobility compris- the cost of infl ation. Thus, in the presence of an asymmetric es the free movement of labour and capital. As Mundell points shock, the central bank’s monetary policies to overcome the out, residents of depressed regions can migrate to prosper- shock in some countries would come at the expense of oth- ing regions.7 In addition, Eichengreen identifi es capital move- ers. According to Clement et al., adjustment to asymmetric ments as an alternative stabilisation tool.8 International capital shocks must occur through labour mobility, changes in price fl ows reduce the danger of balance-of-payments problems and wage levels, and fi scal transfer payments among member that result in devaluation and capital losses for foreign inves- states.4 tors, as money can be easily shifted into more favourable in- vestments. A transfer system may also contribute to overcom- The OCA criteria ing economic shocks.9 Transfer payments can support the recovery of depressed countries if a country that runs the risk The OCA theory offers a set of criteria with which to assess of sliding into recession receives transfer payments from other a country’s suitability for membership in a currency union. member countries. These criteria can be divided into two groups. The fi rst group consists of criteria that reduce the exposure of member coun- Evaluation of the EMU as a currency area tries to asymmetric shocks: similarity of economic structure, openness/intraregional trade and a low degree of specialisa- Ehrig et al. point out that the idea of European economic inte- tion. The second contains criteria that facilitate the adjustment gration was and is still based on the endogeneity hypothesis, to asymmetric shocks: homogeneity of preferences, factor which states that political integration automatically follows mobility and transfer payments. the welfare increase gained through economic integration.10 EMU optimists believed that a common currency would fur- Looking at the fi rst group of criteria, Baßeler et al. point to the ther stimulate labour and capital mobility and thus induce a importance of countries’ similarity in economic structure.5 A greater degree of economic integration.11 Nonetheless, pes- currency union’s exposure to asymmetric shocks is reduced simists and advocates of the heterogeneity hypothesis, such if the differences among member countries are small. That is as Karras and
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