Is European Union an Optimum Currency Area?  

    Introduction:  The theory of the optimal currency area was pioneered in 1961 by Canadian economist Robert Mundell but others point to earlier work done in the area by Abba Lerner. Kenen (1969) and McKinnon (1963) were further developers of this idea. Optimum currency areas are groups of regions with economies closely linked by trade in goods and services and by factor (capital and labor) mobility. If factor mobility between economies in a region is high, the region constitutes an optimum currency area so it means that it has a common currency. The concept is close to the debate between fixed exchange rates and floating exchange rates.


    Definition: An optimum currency area (OCA) is a geographical region in which it would maximize economic efficiency to have the entire region share a single currency, unified currency will provide the best balance of economies of scale to a currency and effectiveness of macroeconomic policy to promote growth and stability. On other hand, the Optimum currency area states that regions that are not bounded by national borders and share certain traits should share a common currency.

    Optimal Currency Area (OCA) Criteria

According to Robert Mundell, there are four main criteria for optimal currency area which is given in following:

    High labor mobility throughout the 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 the remittance of pensions or government benefits.                      

    Capital mobility and price and wage flexibility: This ensures that capital and labor will flow between countries in the OCA according to the market forces of supply and demand to distribute the impact of economic shocks.

                                                                       

    A currency risk-sharing or fiscal mechanism to share risk across countries in the OCA:      This requires the transfer of money to regions experiencing economic difficulties from countries with surpluses, which may prove politically unpopular in higher-performing regions from which tax revenue will be transferred. The European sovereign debt crisis of 2009 to 2015 is considered evidence of the failure of the European Economic and Monetary Union (EMU) to satisfy these criteria as original EMU policy instituted a no-bailout clause, which soon became evident as unsustainable.                                                                                                                               Similar business cycles: Cyclical ups and downs that are synchronous, or at least highly correlated, across countries in the OCA are necessary since the OCA’s central bank will by definition be implementing a uniform monetary policy across the OCA to offset economic recessions and contain inflation. Asynchronous cycles would unavoidably mean that a uniform monetary policy will end up being counter-cyclical for some countries and pro-cyclical for others.

Is European Union an Optimum Currency Area?

According to Robert Mundell, an optimal currency area in which benefits of sharing a common currency is surpassed, where the common currency would create the greatest economic efficacy or benefit. Mandel most of the essays have focused on the idea of international and sub-national regions as optimum currency areas. One of the benefits of optimal currency is which makes the transaction cost lower in member country that is the cost of making in economic exchange, but in the case of the European union, this primarily refers to the cost incurred when doing business or conducting an economic transaction with the deference countries with deference currency.

Is European Union an optimum currency area? Robert Mundell states that about the mobility of production factors. In the event the factors of production are mobile inside the countries which form a monetary union, a country experimenting with adverse shocks might no longer be affected by unemployment and recession. An optimum currency is an area, mainly due to the reduced mobility of the workforce factor (labor and capital). Actually, the mobility of this factor is more reduced in the European Union, even inside each Member State, as compared to the USA or Canada.

   The Maastricht Convergence Criteria and the Stability and Growth Pact

    The Stability and Growth Pact (SGP), originally proposed by German Finance Minister Theo Waigel and fully realized in the late 1990s, was intended to keep European states from exerting excess inflationary pressures on the entire European economy, by maintaining fiscal discipline amongst the members of the Economic and Monetary Union (EMU). Its purpose was two-fold: to bring the economies of countries that would comprise the Eurozone into convergence before the adoption of the common currency, and to maintain compliance with the Pact’s criteria post-implementation of the Eurozone. There are some criteria for convergence in the Maastricht treaty of the European Union which is given in the following:

    The country’s inflation rate in the year before admission must be no more than 1.5 percent above the average rate of the three European Union member states with the lowest inflation.

The country must have a public-sector deficit no higher than 3 percent of its GDP (Gross Domestic Product).

The country must have a public debt that is below a reference level of 60 percent of its GDP (Gross Domestic Product.

Account Balances of Euro Zone countries, 2005-2009 (percent of GDP)

 

Greece

Ireland

Italy

Portugal

Spain

Germany

2005

7.5

3.5

1.7

9.4

7.4

5.1

2006

11.2

4.1

2.6

9.9

9.0

6.5

2007

14.4

5.3

2.4

9.4

10.0

7.6

2008

14.4

5.3

3.4

12.0

9.8

6.7

2009

14.6

2.9

3.1

10.3

5.4

5.0

This table shows by 2008, Greece had a deficit of 14.6 percent of its output, while Spain, a much larger country, was borrowing around 10 percent of its output from abroad. In contrast, Germany, which had worked hard in previous years to reduce manufacturing costs, was running a big surplus.

Conclusion:

    In conclusion, we could appreciate that European Union fulfills certain criteria to establish within the theory of optimum currency area. Europe’s single currency experiment is the boldest attempt ever to reap the efficiency gains from using a single currency over a large and diverse group of sovereign states. If the euro project fails, however, its driving force, the goal of European political unification, will be set back. Robert Mundell is one of the warm supporters of the idea of European monetary unification.

 

By: Sumiya Dost

The writer is a student at the Economics Department University of Turbat

Turbat Kech Balochistan